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CHAPTER 16

LIABILITY FOR CORPORATE ACTS: PIERCING THE CORPORATE VEIL


(OR DISREGARDING THE CORPORATE ENTITY) AND RELATED CONCEPTS

I. INTRODUCTION

A. Exceptions to Salomon Principle

The Salomon case (discussed in chapter 14) is often cited for proposition that a corporation is a
separate legal entity. However, as a judge in India once said “a great deal of water has flown
down the Ganges since Salomon v. Salomon.” The courts have often disregarded the concept of
the corporation as a separate person or separate legal entity to assign liability to individual
shareholders, directors or officers or a corporation. It is often referred to as “piercing the
corporate veil.”

According to Madam Justice Wilson in Kosmopolous v. Constitution Insurance Co. of Canada


[1987] 1 S.C.R. 2 exceptions have been made to the principle of Salomon where it would be “too
flagrantly opposed to justice” to apply the principle of the Salomon case. This is arguably an
accurate summary of the cases in which courts have disregarded the corporate entity.
Unfortunately, while accurate, it is not a particularly helpful guide. Different people have
different conceptions of what is unfair or opposed to justice. As Madam Justice Wilson also
noted in the Kosmopolous case, the situations in which courts will disregard separate corporate
personality follow no consistent principle.

B. Approach

We will take three approaches to getting a handle on when a court may disregard the concept of
separate corporate personality. One is to look at the reasons courts have given for disregarding
the corporate entity. It is useful to know the rhetoric of the courts when one is litigating a case
before a judge who will feel obliged to provide reasons supported with reasons given by judges
in previous cases. Unfortunately the reasons courts have given for disregarding the corporate
entity, as Madam Justice Wilson put it in the Kosmopolous case, “follow no consistent principle”
and thus are not particularly helpful in terms of assessing when a court will be willing to
disregard a corporation’s to the separate corporate entity.

To get a better sense of when a court will disregard the corporate entity a second approach is to
look at various types of cases where courts have disregarded the corporate entity and to examine
how these might fit a reasonable theory in favour of disregarding the corporate entity. The third
approach we will take is to look at some possible broader policy reasons for the disregard of the
corporate entity. In this third approach we will look back at, and make use of, the potential
benefits of limited liability set out in chapter 10.
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C. A Cautionary Remark

We will examine several cases in this chapter in which the court has “disregarded the separate
corporate entity” or “pierced the corporate veil.” This can lead one to the erroneous conclusion
that courts will quite readily disregard the corporate entity or pierce the corporate veil.
However, one overriding message that one should take away is that courts rarely pierce the
corporate veil and one should thus be aware that a case that requires asking the court to pierce
the corporate veil will probably be an uphill battle.

II. THE LEGAL RHETORIC AND ITS BASIS IN THE SALOMON CASE

Objective:

Closed / Open Book:

Be able to set out the reasons courts have given for disregarding the separate corporate
personality and apply them in connection with a particular fact pattern.

A. Agency, Alter Ego, Puppet, Instrumentality, Sham or Cloak

The trial judge in the Salomon case said that Salomon could not claim on the debentures and
would be personally liable to the creditors on the basis that the corporation was just an agent of
Salomon. The effect of this is that the debts incurred by the corporation are really the debts of
the shareholders as principals and the shareholders, as principals, are also liable for the tortious
acts of the corporation in acting within the scope of its authority. This concept has been picked
up on in subsequent cases that refer to the corporation as being simply the agent of the
shareholder (or shareholders). In other cases they more loosely refer to the corporation as the
“alter ego,” “puppet,” or “instrumentality” of the shareholder, as a “conduit” for the shareholder,
or as a mere “sham” or “cloak” for the shareholder.

The court may support such a conclusion by saying that the shareholders themselves failed to
treat the corporation as a separate entity. In doing so they may look to facts such as a failure of
shareholder to keep separate accounting records for the corporation, the failure to maintain
corporate records that the corporation is required to maintain, the failure to hold corporate
meetings, the failure to make regular corporate filings, and so on.

B. Disregard of Corporate Entity by the Shareholders or Directors Themselves

When piercing the corporate veil courts also refer to the failure of the shareholder(s) to maintain
the separate identity of the corporation. For instance, the court may refer to the failure to keep
separate books for the corporation, the failure to maintain corporate records, the failure to hold
corporate meetings, the failure to make regular corporate filings, and so on.
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C. Conduct Akin to Fraud

When courts disregard the corporate entity they occasionally say they are doing so on the basis
that the promoters of the corporation used the corporation to engage in “conduct akin to fraud.”
The English case of Gilford Motors v. Horne, which used the “conduct akin to fraud” expression,
is often referred to in this context. Gilford Motors v. Horne is discussed further below.

D. Affiliated Enterprises

The courts appear to be more willing to disregard the corporate entity where the effect of doing
so is to link a parent company with its subsidiary or to link a subsidiary with one or more other
subsidiaries through a parent corporation. In other words, the court will look at the whole group
of related corporations or at what is sometimes referred to as the whole “corporate enterprise.”
The tests often cited and considered in making such a linkage are the tests set out in the case of
Smith, Stone and Knight Ltd. The tests were set out as a basis for determining whether the
subsidiary was really just an agent of the parent corporation.

1. Smith, Stone and Knight Ltd. v. Birmingham Corporation, [1939] 4 All E.R. 116

In Smith, Stone and Knight Ltd. v. Birmingham Corporation, [1939] 4 All E.R. 116 Smith, Stone
and Knight Ltd. owned all the shares of a subsidiary company that carried on business in
Birmingham. The City of Birmingham expropriated the premises on which the subsidiary
carried on business. Smith, Stone and Knight Ltd. sought compensation for the expropriation.
The City of Birmingham challenged the right of Smith, Stone and Knight Ltd. to seek
compensation since it was a separate legal entity – the subsidiary company – that carried on
business on the premises. The law with respect to expropriation was such that a considerably
lesser amount would be paid if it was the subsidiary’s claim.

The court said that an exception to the Salomon principle arises where the corporation is simply
an agent of the shareholder. The tests suggested were:

(i) Were the profits treated as profits of the parent company?


(ii) Were the persons conducting the business appointed by the parent company?
(iii) Was the parent company the head and brain of the trading venture?
(iv) Did the parent company govern the trading venture, decide what should be done
and what capital should be embarked on the venture?
(v) Did the parent company make profits by its skill and direction?
(vi) Was the parent company in effectual and constant control?

Applying these tests to the particular facts the court found Smith, Stone and Knight Ltd. to be a
proper claimant (i.e. the separate corporate entity of the subsidiary was disregarded).

The problem with these tests is that the answers seem to be yes, yes and yes in virtually every
parent-subsidiary relationship. But the corporate entity of subsidiaries is not disregarded in
every affiliated company case. There must be something more going on in these cases.
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2. Alberta Gas Ethylene Co. v. M.N.R., [1989] 41 B.L.R. 117 (Fed. T.D.) Aff’d [1990] 2
C.T.C. 171 (Fed. C.A.)

In Alberta Gas Ethylene Co. v. M.N.R., [1989] 41 B.L.R. 117 (Fed. T.D.) Aff’d [1990] 2 C.T.C.
171 (Fed. C.A.) Alberta Gas Ethylene Co. (“AGEC”) sought financing in the U.S. for a pipeline.
The financing was to come from various insurance companies in the U.S. The insurance
companies faced restrictions on the non-domestic proportion of their investment portfolios.
Because of these restrictions they charged a higher rate of interest for non-domestic loans. To
get the lower rate of interest AGEC incorporated a Delaware subsidiary under the name Alberta
Gas Ethylene Company Security Corporation (“ASCO”). The loan from the insurance
companies was made to ASCO. ASCO then made a loan in a corresponding amount to AGEC.
AGEC also paid interest to ASCO in the same amount that ASCO was required to pay on the
loan to the U.S. insurance company lenders.

The Minister of National Revenue assessed AGEC for withholding taxes on interest payments
made to ASCO as a non-resident. AGEC argued:

(i) ASCO had no existence. It was just “a straw man”, “a shell company” and no more
than a borrowing arm of the plaintiff. Thus the court should “lift the corporate veil” and
look at the substance of the transaction. It would then become obvious that ASCO was
doing nothing more than carrying on the business of the plaintiff.

(ii) ASCO was just its agent. In support of this it was argued that the six tests in Smith,
Stone & Knight were satisfied.

The trial division held that it is not

“sufficient to consider the six criteria and when they are all met (as they are in the present
case) to ignore the separate legal existence of the subsidiary company. One has to ask for
what purpose and in what context is the subsidiary being ignored.”

The court further said:

“What is more, I do not interpret the jurisprudence as ignoring the existence of subsidiary
corporations per se. Rather, it seems to me that the jurisprudence proceeds on the basis
that in certain circumstances, consequences will be drawn despite the legal existence of
separate subsidiary corporations.”

3. Gregorio v. Intrans-Corp. (1984), 18 O.R. (3d) 527 (C.A.)

In Gregorio v. Intrans-Corp. (1984), 18 O.R. (3d) 527 (C.A.) Gregorio bought a truck from
Intrans-Corp. that was defective (vibrations were caused by an improperly aligned frame).
Intrans-Corp. ordered the truck through Paccar Canada Ltd. (also known as Peterbuilt of Canada)
which was the Canadian subsidiary of the U.S. manufacturer, Paccar Inc. Paccar Canada Ltd. in
turn ordered the truck from Paccar Inc. A breach of warranty claim by Gregorio was successful
against Intrans-Corp. Gregorio also made a claim against Paccar Canada Ltd. for negligent
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manufacture of the truck (and there was an indemnification claim by Intrans-Corp. against
Paccar Canada Ltd.). However, Paccar Canada Ltd. did not manufacture the truck – its parent
company Paccar Inc. manufactured the truck. The argument to make Paccar Canada Ltd.
responsible for the negligent manufacture of the truck was that it was one and the same person as
the parent company Paccar Inc.

The Court of Appeal held that the trial judge erred in disregarding the corporate entity of the
subsidiary Paccar Canada Ltd. Laskin, J.A. for the court said,

“Generally, a subsidiary, even a wholly owned subsidiary, will not be found to be the
alter ego of its parent unless the subsidiary is under the complete control of the parent
and is nothing more than a conduit used by the parent to avoid liability. The alter ego
principle is applied to prevent conduct akin to fraud that would otherwise unjustly
deprive claimants of their rights.” (emphasis added)

III. SITUATIONS IN WHICH COURTS APPEAR TO BE MORE INCLINED TO


PIERCE THE CORPORATE VEIL AND THE POSSIBLE ASSOCIATED
POLICY EXPLANATIONS

Objective:

Closed / Open Book

1. Be able to assess whether a particular situation is of a type in which a court is likely to


disregard the corporate entity with reference to case authority.

2. Be able to articulate possible policy reasons for disregarding the corporate entity in each
of the situations discussed below.

Open Book

In a given fact situation assess whether a court is likely to disregard the corporate entity on the
basis of whether the case fits within one of the following situations.

A. Gap Filling and Implied Contractual Terms

1. Gap Filling and Transactions Costs Reduction

Gap Filling

Courts may disregard the corporate entity in a way that amounts to filling in the gaps in
contracts. In other words, they disregard the corporate entity to achieve what the parties would
have agreed to had they turned their minds to the particular facts that have arisen in the case. By
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disregarding the corporate entity the court is effectively filling in the gap. It is essentially saying
that although the parties did not put in a provision restricting the use of a corporation to avoid
obligations under the agreement, such a provision would have been put in had the parties
directed their minds to it. By disregarding the separate corporate entity of the corporation the
court is essentially implying such a provision or filling in a clear gap in the contract.

Transaction Costs

One might simply let the loss lie where it falls and thus give the parties an incentive to be more
careful in setting out the terms of their agreement and contemplating potential pitfalls. However,
there may have been numerous ways in which a creative use of a corporation might have allowed
a person to avoid the basic obligation entered into in a contract. Trying to anticipate all of the
possible creative uses of corporations in advance and then drafting provisions that protect against
those creative uses of corporations to avoid contractual obligations could be very costly. The
cost may be sufficient to make the contract no longer worthwhile. Otherwise it may affect the
consideration offered under the contract since one, or possibly both, of the parties must be
compensated for the cost of negotiating and drafting provisions that deal with various uses of
corporations to avoid contractual obligations. If the court did not fill in the gaps the cost of
transactions may well be substantially increased. By filling in gaps the court is thus arguably
reducing the cost of entering into transactions.

Courts do have to be careful, however, that they fill in the gaps in the way the parties likely
would have filled in the gaps. If they impose obligations on parties that they would not have
anticipated then persons entering into similar future transactions will have to put in detailed
provisions to avoid the problems courts create by mistaken gap filling. In other words, gap-
filling mistakes by courts can lead to higher transactions costs if the court does not follow an
approach of being reasonably certain about how the parties would have filled in the apparent
gap.

2. Examples

(a) Gilford Motor Company Ltd. v. Horne, [1933] Ch. 935 (C.A.)

Gilford Motor Company Ltd. v. Horne, [1933] Ch. 935 (C.A.) provides a very simple example of
the gap filling theory. Horne had been the managing director of Gilford Motors Company Ltd.
until he resigned in 1931. His employment contract had a non-competition clause that said he
was not to engage in a competing business with a radius of three miles of Gilford Motor
Company Ltd. for a period of five years after leaving his employment with Gilford Motor
Company Ltd. Horne tried to avoid the clause by setting up a company (J.M. Horne Co.) with
the shares divided equally between his wife and an employee. J.M. Horne Co. carried on the
same business as Gilford Motor Company Ltd. within the three mile radius and within the five
year period.

The English Court of Appeal held that the company was a sham designed to avoid Horne's
obligations under the contract. The court treated Horne and the J.M. Horne Co. as one and the
same person. Thus the competing business of J.M. Horne Co. was treated as Mr. Horne’s own
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competing business and he had thus violated the non-competition clause in his employment
contract. The court said that Mr. Horne had used the company (J.M. Horne Co.) to engage in
“conduct akin to fraud”.

The problem of the incorporation of a company to engage in a competing business might easily
have been avoided by a more carefully drafted non-competition clause that made it clear that if
Mr. Horne was a major shareholder or significant employee of a competing company that would
also be a violation of the clause. However, this would require that the parties turn their minds to
a range of ways in which the non-competition clause could be avoided and negotiate their way to
a satisfactory resolution of the clause. Even then the clause might not catch all the possibilities
for avoiding the application of the clause. Thus by treating the J.M. Horne Co. and Mr. Horne as
one and the same person the court was essentially filling a gap in the contract in a way that the
parties presumably would have had they turned their minds to it. The willingness of courts to do
this helps contracting parties avoid the costs of fully specifying every means by which a
corporation could be used to avoid a contract.

The court said that the reason for disregarding the corporate entity of J.M. Horne Co. was that it
was being used to engage in “conduct akin to fraud.” The difficulty with this test is that it can be
very hard to assess what kind of conduct is “akin to fraud.” It apparently doesn’t have to amount
to common law fraud but can be something less than fraud but “akin” to it. What Mr. Horne was
doing was breaching a contract. The general rule in contract is “perform or pay.” A breach of
contract is not fraud, nor is it really akin to fraud. It is simply a choice of the party to the
contract. It is a stretch to say that an ordinary breach of contract, at least as it has been
understood in the common law, is fraud, or even akin to fraud.

(b) Saskatchewan Economic Development Corporation v. Patterson-Boyd Mfg. Corp. [1981]


2 W.W.R. 40

Gilford Motors v. Horne provides a relatively simply example of gap filling. Saskatchewan
Economic Development Corporation v. Patterson-Boyd Mfg. Corp. provides a more complicated
version of the same principle at work.

In Saskatchewan Economic Development Corporation v. Patterson-Boyd Mfg. Corp. Paterson-


Boyd Mfg. Corp. (“PB Mfg.”) received a loan from Saskatchewan Economic Development
Corporation (“SEDCO”) pursuant to a contract to which the PB Mfg. shareholders, Patterson,
Boyd and Hoffman, were parties. The contract bound the PB Mfg. to not pay principal or
interest on any loan from a shareholder or an “associated company” until SEDCO had been paid
in full for its loan. The contract also prohibited sales to the company in which any PB Mfg.
director or major shareholder was directly interested unless the sale was made at prevailing
market prices and credit terms. Patterson, Boyd and Hoffman also each executed an
“Assignment and Postponement of Claim” document under which they postponed all present and
future claims by them against PB Mfg. to SEDCO.

PB Mfg. got into financial difficulty and the bank from which the company had a loan on a
revolving line of credit reduced PB Mfg. line of credit from $200,000 to $100,000. This reduced
line of credit meant that PB Mfg. did not have sufficient funds to carry on its manufacturing
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business. Patterson and Boyd incorporated a new corporation by the name of PB Fabricators
Ltd. and deposited funds in PB Fabricators. PB Fabricators then made a loan to PB Mfg. PB
Mfg. issued a debenture (evidence of the loan) to PB Fabricators that gave PB Fabricators a first
encumbrance on inventory of PB Mfg.’s custom manufacturing business. PB Mfg. had both a
pump manufacturing business and a custom manufacturing business and the encumbrance only
covered the inventory in the custom manufacturing business. Paterson and Boyd argued that the
custom manufacturing business was a new business of PB Mfg. that had not been carried on by
PB Mfg. when SEDCO had advanced funds to PB Mfg.

The trial judge upheld the validity of the debenture issued to PB Fabricators. However, the
Saskatchewan Court of Appeal first rejected the finding that custom manufacturing business was
not carried on at time of SEDCO loan and thus the postponement of claims by shareholders and
associated companies in the SEDCO loan agreement applied to the custom manufacturing
business. The Court of Appeal also held that the term “associated company” in the SEDCO loan
agreement included a company with which the shareholders were associated so that the clause
about the postponement of payments of principal and interest precluded payments to PB
Fabricators before SEDCO was paid. That was sufficient to dispose of the case. However, the
term “associated company” was not clearly defined and, given the uncertainty, the Court of
Appeal went on to hold that even if PB Fabricators was not an “associated company” the court
should lift the corporate veil. The shareholders of PB Mfg. were using PB Fabricators to do
things which they had contracted not to do under the terms of their agreement. The loan by PB
Fabricators was really a loan by the shareholders of PB Mfg. (i.e. by Patterson and Boyd). The
court cited Gilford Motor Company Ltd. v. Horne as authority for piercing the corporate veil in
this situation. The Court of Appeal thus concluded that the debenture to PB Fabricators should
be subordinated to the debenture of SEDCO since the debenture issued to PB Fabricators was
really in favour of Patterson and Boyd who had promised to postpone their claims in favour of
SEDCO.

The piercing of the corporate veil here was arguably obiter dictum given the court’s
interpretation of the contract, particularly the expression “associated company”. However, this
would have amounted to saying that PB Mfg. had breached its contract with SEDCO by making
payments to PB Fabricators and the remedy would have been damages against PB Mfg. PB Mfg.
was now bankrupt and thus a remedy of damages might have just been a Pyrrhic victory for
SEDCO. Piercing the corporate veil made PB Fabricators and Patterson and Boyd parties to the
breach since they were one and the same with PB Mfg. This allowed SEDCO to obtain damages
for breach of contract from PB Fabricators and Patterson and Boyd.

Here it seems clear that what was done by Patterson and Boyd was what was intended would not
be done (i.e. payments effectively to PB Mfg. shareholders (via PB Fabricators) on a loan from
the shareholders). By piercing the corporate veil the court is getting the result the parties would
presumably have agreed to had they turned their minds to it. Indeed the provisions concerning
postponement of claims by shareholders and “associated companies” suggest that the result the
court arrived at was what was apparently intended in the contract. If the court did not pierce the
corporate veil in cases such as this then the SEDCO lawyers, and other lawyers dealing with
similar contracts, would have to write much more extensive clauses to cover all possible means
by which a separate corporation might be used to avoid the contract. In other words, piercing the
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corporate veil in these cases can fill gaps in contracts and thereby avoid unnecessary transactions
costs in the drafting of contracts.

B. Corporations Formed to Avoid Statutory Requirements

1. Statutory Gap Filling

In some cases the corporation may be used as a means of avoiding a statutory requirement or
restriction. If the court disregards the separate corporate personality in these cases it is arguably
engaged in a form of gap filling just as it is in the case of filling gaps in contractual terms. In
other words, the court is effectively saying that if the legislature had turned its mind to the
situation now before the court it would surely have dealt with the matter by putting in a
provision that prevented the use of a corporation to avoid the statutory obligation or restriction.
As with contractual gap filling, there may be many ways in which a corporation can be used to
avoid statutory requirements or restrictions. If the legislature were required to anticipate all of
these situations it could make the legislative drafting process very costly and dilatory.

2. Example

(a) British Merchandise Transport Co. Ltd. v. British Transport Commission, [1961] 3 All
E.R. 495

British Merchandise Transport Co. Ltd. v. British Transport Commission, [1961] 3 All E.R. 495
provides a simple example of statutory gap filling. In this case there was legislation that
permitted only one licence per person. In particular it did not permit a holder of a C licence to
also hold an A licence. The petitioner was a corporation that held a C licence. It formed a
subsidiary corporation and the subsidiary corporation applied for an A licence. The licence was
refused on the basis that the petitioner already held a C licence and the legislation said that the
holder of a C licence could not also hold an A licence. The petitioner responded that the person
applying for the licence, the subsidiary corporation, did not hold a C licence (indeed, it did not
hold any licence). The subsidiary was a separate company from the parent company that held a
C licence and thus the fact that a separate person (the parent company) held a C licence was
irrelevant. The petitioner said that the legislation thus did not permit the refusal of a licence to
the subsidiary and the petitioner sought an order of mandamus requiring the registrar under the
legislation to issue a licence to the subsidiary.

The court held that the licence was legitimately refused. The subsidiary corporation was used as
a mere device to do precisely what the legislation said one could not do.

Here again the court was arguably filling in a gap. The drafters of the legislation might have
dealt with ways in which a corporation could be used to avoid the one licence per person
provision in the legislation. There might have been many permutations of the use of a
corporation to avoid the legislative restriction and addressing all the possibilities in the
legislation might have been costly and might have significantly delayed the legislation. Piercing
the corporate veil in these situations may help avoid some of these costs.
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3. Tax Avoidance Cases

Perhaps the most frequent cases that would arguably fit in the statutory gap filling category are
tax cases. The courts have shown a willingness to disregard the corporate entity in many of
these cases. These cases involve situations in which a corporation has been used to avoid taxes.
If that is the only purpose for the corporation then the court may be willing to disregard the
separate corporate entity.

The Income Tax Act is a good example of the degree of detail that may be required to close off
gaps if the court does not close them off. For many years the principle of interpretation of taxing
statutes was that that a tax would not be imposed unless the legislation very clearly laid out the
obligation to pay tax (i.e. taxing statutes were interpreted quite strictly). This may explain in
part the length and detail of the Income Tax Act much of which is directed at warding off
attempts to avoid tax. Trying to anticipate every way in which a corporation might be used to
avoid all the taxing provisions of the Act may be near to impossible and attempting to do so
would probably make the Act even more complex. On the willingness of courts to disregard the
corporate entity in tax cases see Dunford, The Corporate Veil in Tax Law (1979), 27 C.T.J. 282.

C. Affiliated Corporations

Part II above noted the legal rhetoric invoked by courts when they pierce the corporate veil
between affiliated corporations. Generally courts appear much more willing to pierce the
corporate veil between affiliated corporations. Let’s now consider why courts may be more
willing to pierce the corporate veil between affiliated corporations. One reason for this
willingness can be highlighted by contrasting two U.S. cases – Mangen v. Terminal Cabs Ltd.,
272 N.Y. 676 (1936 N.Y.A.D.) and Walkovsky v. Carlton, 223 N.E. 2d 6 (1966).

Mangen v. Terminal Cabs Ltd. and Walkovsky v. Carlton are interesting because they involve
essentially the same fact pattern with one key difference. In Walkovsky v. Carlton Carlton
carried on a taxicab business. He set up ten separate cab companies. Each cab company’s assets
consisted of just two taxicabs. Taxicab companies tend to use old cars and they get a lot of
mileage and a lot of abuse. The cabs in each of these companies were probably not worth very
much. Each company carried the statutory minimum required third party liability insurance of
$10,000. Walkovsky was a pedestrian who was struck by a taxicab owned by one of these ten
taxicab companies. His injuries were significant and the assets of the cab company (Seon Cabs
Inc.), together with the insurance of $10,000, were not sufficient to compensate Walkovsky for
his injuries. He sought to have the court disregard the corporate entity and make Carlton
personally liable. A majority of the court refused to make Carlton personally liable for
Walkovsky’s injuries.

In Mangen v. Terminal Cabs Ltd. Terminal Cabs Ltd. was the parent company of four subsidiary
taxicab companies owning 60% of the shares of each of the subsidiary companies (the other 40%
of the shares of each of the companies being held by two individual shareholders). The plaintiffs
were injured when their car hit a pillar after swerving to avoid a cab owned by one of the
subsidiary companies. The trial court held that the accident was the result of the negligence of
the taxicab driver and that there was no contributory negligence by the plaintiffs. The plaintiffs
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sought to pierce the corporate veil of the subsidiary to get to the parent company Terminal Cabs
Ltd. The court in this case did pierce the corporate veil.

The diagrams below provide a pictorial representation of the facts in these two cases. One
essential difference in the cases was that in Walkovsky v. Carlton the shares of the separate cab
companies were each owned by an individual, namely, Carlton. In Mangen v. Terminal Cabs the
shares of the subsidiary cab companies were owned by another corporation (Terminal Cabs
Ltd.).

Walkovsky v. Carlton

Carlton
each corpn. thinly capitalized

.......... SEON CAB


CORP.

taxi taxi

Mangen v. Terminal Cabs Ltd.

s/h

Terminal Cabs Ltd.

............... Subco.

taxi taxi

Why was the court willing to pierce the corporate veil in Mangen v. Terminal Cabs Ltd. but not
in Walkovsky v. Carlton? Piercing the corporate veil in the Mangen case did not get to the assets
of an individual shareholder. The shareholders of Terminal Cabs Ltd. were made worse off
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because their shares would now be worth less since the assets of Terminal Cabs Ltd. would be
reduced. However, they would not be personally liable. Thus a shareholder in Terminal Cabs
Ltd. would not have to worry about the ability of other shareholders to provide compensation or
their ability to contribute to any losses that that particular shareholder was called upon to pay. In
short, the benefits of limited liability discussed in chapter 10 would not be lost. Shareholders in
Terminal Cabs Ltd. would not have to be checking the wealth of their fellow shareholders or
monitoring their wealth, etc.

Courts may not articulate the benefits of limited liability when they make decisions on piercing
the corporate veil but they do seem to have a sense of the potentially significant implications of
piercing the corporate veil. This is apparent in their general reluctance to pierce the corporate
veil but also in their apparent greater willingness to pierce the corporate veil between affiliated
corporations. The reason for this greater willingness may be that the sense that the benefits of
limited liability are not lost when the court does pierce the corporate veil between affiliated
corporations. In Walkovsky the majority decision noted that

“it is one thing to assert that a corporation is a fragment of a larger corporate combine
which actually conducts the business. … It is quite another to claim that the corporation
is a “dummy” for its individual stockholders who are in reality carrying on the business
in their personal capacities for purely personal rather than corporate ends… Either
circumstance would justify treating the corporation as an agent and piercing the corporate
veil to reach the principal but a different result would follow in each case. In the first,
only a larger corporate entity would be held financial responsible … while in the other,
the stockholder would be personally liable.”

D. Misrepresentations

1. Misrepresentation Theories

If the business enterprise is conducted through a form of association that provides limited
liability for equity investors and the voluntary claimants are aware of this they can either refuse
to deal with the business enterprise or charge a premium that reflects any added risk that they
will not be paid or that other terms of the contract will not be performed. The opportunity to
refuse to deal or to charge a premium depends on whether the voluntary claimant is aware of the
limited liability of the equity investors. The voluntary claimant can check this ahead of time but
it will involve some cost (the “screening cost”). Screening costs may be reduced by a legal
requirement that the business enterprise provide a signal of whether equity investors have limited
liability or not (e.g. by requiring the addition of a suffix to the business enterprise name such as
“Ltd.” or “Limited Partnership”).

The persons operating the business enterprise might be inclined to misrepresent the situation and
mislead persons dealing with the business enterprise into believing that the equity investors in
the business enterprise will not have limited liability. That way they may be able to avoid
having voluntary claimants charge a premium for the added risk of equity investor limited
liability. If business enterprises were allowed to succeed in such misrepresentations it would
make it more difficult for persons dealing with business enterprises to determine whether any
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particular business enterprise provided limited liability to its equity investors. Persons dealing
with a business enterprise would seem to be left with three options: (i) incur additional screening
costs to determine whether the equity investors did indeed have limited liability; (ii) incur the
cost of obtaining personal guarantees from the investors; or (iii) just charge a premium without
bothering to either assess whether the equity investors have limited liability or arranging for
personal guarantees from the equity investors. Whichever approach is taken it increases the
costs of business transactions across the board. Making equity investors personally liable where
they have misrepresented the extent of their liability avoids the incurrence of these added costs.
Equity investors should be made liable even where the misrepresentation is inadvertent since it is
presumably cheaper for the equity investors to be aware of the legal status of the business
enterprise and notify persons who deal with the business enterprise of that status than it is for
each and every person dealing with the business enterprise to independently determine the legal
status of the business enterprise.

The concept of misrepresentation in piercing the corporate veil is that persons dealing with the
corporation are somehow deceived into thinking their contract was with some person other than
the corporation. This is most likely to occur when a business carried on by a sole proprietor or
partners is transferred to a corporation. Persons who dealt with the sole proprietor or partners
before the transfer of the business to the corporation may not be aware of the transfer and deal
with the persons now carrying on the business as agents for the corporation on the understanding
that those persons are still acting on their own behalf as sole proprietor or as partners and are still
thus personally liable for their acts. The shareholders in these situations may be unjustly
enriched by the persons who are so misled where these persons, for example, advance credit on
terms they might not otherwise have had they known of the newly created limited liability of the
proprietors. By piercing the corporate veil in these situations the court compensates the persons
who are misled and creates an incentive for those transferring business assets to corporate
entities to inform persons who previously dealt with them and who might otherwise be unaware
of the limited liability created by the transfer.

2. Examples

(a) Gelhorn Motors Ltd. v. Yee (1969), 71 W.W.R. 526 (Man. C.A.)

Gelhorn Motors Ltd. v. Yee (1969), 71 W.W.R. 526 is an example of a situation in which a
person who had dealt with the business prior to incorporation was not informed of the
incorporation. The defendants, Yee and Wilcox, carried on a car exchange business. They
began dealing with Gelhorn Motors Ltd. in October of 1961. They did not apply for
incorporation until sometime in November of 1961. Eventually a corporation under the name
Empire Car Exchange Ltd. was incorporated. Orders for cars continued to be made after the
incorporation. Gelhorn Motors Ltd. sued for unpaid amounts on cars sold and delivered to the
car exchange business. Gelhorn Motors Ltd. sued Yee and Wilcox. Yee and Wilcox did not
dispute the contract for the cars or the delivery of the cars. Instead they argued that the suit
should be against Empire Car Exchange Ltd. since the business was carried on by Empire Car
Exchange Ltd. and the contract was thus with Empire Car Exchange Ltd. The Manitoba Court of
Appeal held that the evidence indicated that Gelhorn Motors Ltd. had not been made aware of
the incorporation and that Yee and Wilcox were thus personally liable.
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(b) Corkum v. Lohnes (1981), 81 A.P.R. 477 (N.S. App. Div.)

There have been several other cases which involve more questionable applications of a
misrepresentation theory. For instance, in Corkum v. Lohnes (1981), 81 A.P.R. 477 (N.S. App.
Div.) Corkum sued Lohnes for blockage of his right of way and for damages arising from the
pollution of his well. Lohnes had entered into a contract to fell lumber on a property near
Corkum’s property. The contract under which Lohnes agreed to fell lumber was signed in his
own name and in that contract he agreed to indemnify the owner of the property (Mr. Fancy) “for
any and all claims made by anyone against the [owner] in respect to damages or trespasses or
any other claim in respect to the said lands.” One of the defences raised by Lohnes was that the
action should have been brought against Elmer Lohnes Lumbering Ltd. and not against him
personally because it was Elmer Lohnes Lumbering Ltd. that carried on the business. Thus if
any damage was done to Corkum it was done not by him personally but by Elmer Lohnes
Lumbering Ltd. Lohnes was estopped from denying responsibility for the blockage of the right
of way or damages to the well since he had signed the contract with the nearby property owner
(Mr. Fancy) in his own name.

The contract in question here was not a contract between Corkum and Lohnes – it was a contract
between Lohnes and Mr. Fancy. Lohnes’ failure to sign the contract with Fancy in the name of
the company was nonetheless treated as preventing Lohnes from denying personal liability.
Corkum was thus not misled in entering into a contract. This was tort claim. The theory for
piercing the corporate veil in this case probably fits more with the non-consensual claimants
considerations discussed in part III E below.

(c) Chiang v. Heppner (1978), 85 D.L.R. (3d) 487 (B.C.)

Chiang v. Heppner (1978), 85 D.L.R. (3d) 487 (B.C.) provides an example of a much less
plausible case of misrepresentation. Chiang left her $2,500 watch with Mr. Heppner for repair.
Although the business was carried on under the name Heppner Jewellers Ltd., Chiang received a
receipt ticket in the name of “Heppner Credit Jewellers”. Chiang returned to the store
approximately ten times in the next several months but the watch was never ready because
certain parts had been lost by the defendant. Mr. Heppner had kept the watch in the safe but
when the parts arrived it was left on the work bench while it was being repaired. The store was
destroyed by a fire (that destroyed several shops in the Abottsford Shopping Mall) and the watch
was badly damaged. After dealing with the responsibility of a bailee for value the judge
considered the question of Mr. Heppner’s personal responsibility as follows:

“A further question of the defendant Heppner's personal responsibility arises. It is clear


that Mr. Heppner held himself out to be a sole proprietor and his claim ticket, Ex. 2,
showing the name ‘Heppner Credit Jewellers’, gives no indication of the limited
company. There is no evidence that the plaintiff could in any way have been aware of
the organization, Heppner Jewellers Ltd. All the plaintiff's dealings were with Heppner
on a personal basis. Accordingly, I hold that Heppner has personal responsibility to the
plaintiff.”
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It is unlikely that Chiang’s decision to leave her watch with Heppner was in any way influenced
by whether Heppner’s jewellery business was carried on by Heppner as a sole proprietorship or
through a corporation. There was some indication that although there was insurance for Heppner
Jewellers Ltd. the insurance company was denying liability. That may explain, in part, the
reason the suit was brought against Heppner personally. The plaintiff might have a reasonable
expectation that a watch repair shop would have insurance that would cover losses due to fire
and that any damage to the watch while in the repair shop would be covered under that
insurance. Making Heppner liable here might have simplified matters. Heppner could then
proceed against the insurance company (perhaps through Heppner Jewellers Ltd.).

(c) Tato Enterprises Ltd. v. Rode (1979), 17 A.R. 432 (Alta. Dist. Ct.)

Tato Enterprises Ltd. v. Rode (1979), 17 A.R. 432 (Alta. Dist. Ct.) is a perhaps more difficult
case of misrepresentation. Tato Enterprises Ltd. was owed money on a written contract entered
into with Scott Bradley Ltd. The contract was signed on behalf of Scott Bradley Ltd. by Edward
Rusnak as secretary and by Glen Rode as president. In fact there was no such company. There
was a Scott Bradley Marketing Ltd. but no business had been done through it. Scott Bradley
Marketing Ltd. did not have a bank account and had no assets. Amounts that were paid were
paid by Glen Rode personally. Scott Bradley Marketing Ltd. did not purport to ratify anything
done by Rode. The court held Rode personally liable stating that,

“In this case, …, the corporate formalities have clearly been offended and, in fact, there
has been a wide and broad failure of compliance with corporate formalities. The failure
of the defendant Rode to take the time and trouble to determine the correct name of the
corporation and to conduct his business in that name is simply a further evidence of his
failure to comply with those requirements of The Companies Act which are necessary if a
person purporting to be an agent of a corporation is to avoid personal liability.
Accordingly, the limited liability otherwise available to a director or officer of a body
corporate as the agent of that corporation, is not available to the defendant Rode and it is
my view that the contracting parties in the matters before me are the plaintiff and the
defendant Rode personally.”

Here Tato Enterprises Ltd. must have assumed that it was dealing with a corporation but the
court still made Rode personally liable. Arguably Tato Enterprises Ltd. should have made sure
just who it was dealing with. On the other hand, there was clearly an intended contract but a
mistake was made as to who the parties to the contract were. As between Tato Enterprises Ltd.
and Glen Rode, Glen Rode was arguably the one who could have avoided mistake at least cost.

(d) Roydent Dental Products Inc. v. Inter-dent Int'l Dental Supply Co. of Canada [1993]
O.J. 708

In Roydent Dental Products Inc. v. Inter-dent Int'l Dental Supply Co. the plaintiff, Roydent
Dental Products Inc. had sold goods to Inter-dent International Dental Supply Co. on credit and
was not paid. Roydent had made no inquiry into whether Inter-dent International Dental Supply
was a corporation or not. It was in fact just an unincorporated division of another company.
Nonetheless the shareholder of the company was found personally liable on the basis that the
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shareholder had failed to register the business name of the division and therefore had failed to
comply with requisite legislative formalities. The sole shareholder of the company was made
personally liable.

In this case the plaintiff appears not to have relied in that the plaintiff did not make any inquiries
as to whether the entity dealt with was an incorporated entity or not. However, it would have
been difficult for the plaintiff to make inquiries since the business name was not registered. The
business name also gave a misleading impression that the entity was a corporate entity.

Although the name was potentially misleading for those who are not aware of corporate law, as
students of corporate law I would expect you to now know better than the plaintiff perhaps did
here. Just because the word “company” (or its abbreviation) appears it does not necessarily
mean it is an incorporated entity. It is common for partnerships to add the words “and Co.” and
it is also possible that partners have retired leaving just a sole proprietor continuing to carry on
the business under the “and Co.” name.

3. Failure to Use the Cautionary Suffix

Section 10(5) of the CBCA (and similar sections in other corporate statutes in Canada) require
the corporation to put the corporate name, together with the cautionary suffix (e.g. “Ltd.”) on
every order form, contract, invoice, etc. of the corporation. The consequence of not doing so
under the CBCA is that it is an offence under CBCA s. 251 of the Act not to do so. However,
courts have frequently seized upon this failure to comply with the corporate statute as a basis for
making a shareholder personally liable.

4. Seizing Upon Misrepresentation in Tort Actions to Effect Compensation

In some cases courts seize upon a failure of the promoters of the company to treat the company
as a separate entity in order to effect compensation in tort actions. Tort claimants, however, are
not normally persons who deal with the company in advance and thus are not mislead as to the
nature of the entity they are dealing with. For instance, in Walkovsky v. Carlton Mr. Walkovsky
did not have much choice about whether he was about to be hit by a taxi owned by the thinly
capitalized Seon Cabs Inc. Generally cases involving tort claimants involve concerns other than
misrepresentation but the court may use rhetoric suggesting that some kind of misrepresentation
may have occurred.

For example, in Wolfe v. Moir (1969), 69 W.W.R. 70 Barry Wolfe went roller skating at Fort
Whoop Up operated under the business name “Moir’s Sport Land”. The words “Fort Whoop
Up” were worked into the tiles of the building. In fact the business was carried on through a
corporation, Chinook Sports Ltd. The ticket Barry purchased only referred to Fort Woop-Up and
advertising about Moir’s Sport Land and Fort Whoop Up also did not mention Chinook Sports
Ltd. Other formalities regarding the corporation were apparently also not followed. Barry
Wolfe was injured and sued Moir in his personal capacity. Moir argued that it was the
corporation that carried on the business and that it was thus the corporation that should be sued
for the tort. The court held that Moir had failed to follow statutory requirements and that he
therefore took the risk of being held personally liable.
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What is the effect of a breach of the statutory provision requiring one to use the full corporate
name including the cautionary suffix in all corporate documents? The CBCA says that it results
in a penal sanction for breach of the statute. Nothing in statute says that the consequence is the
disregarding of the corporate entity. This is a consequence the court has imposed in the
circumstances. Generally the failure to comply with corporate formalities, particularly in a sole
shareholder corporation, increases the risk that the corporate entity will be disregarded.

Was there a misrepresentation in Wolfe v. Moir as a result of the failure to use the corporate
name? If the corporate name had appeared on the ticket, in the advertising and, perhaps also in
the roof tiles would Barry Wolfe have made a different decision as to whether he would go roller
skating? If the corporate name had appeared on the ticket and advertising should it have made
any difference as to whether compensation would be provided to Barry Wolfe?

Why should the observation of the corporate formalities be relevant? In some cases the concern
for compensation may be equally as strong but if the corporate formalities are observed then the
tort victim may not be compensated. Is the effect of penalizing those who do not follow the
corporate formalities a way of encouraging those who incorporate companies to engage lawyers
to assure that the corporate formalities are observed? Is there any other real benefit to ensuring
that corporate formalities are observed?

E. Non-Consensual Claimants, Distributive Justice and Incentive Costs

The primary example of an involuntary claimant (or non-consensual claimant) would be the
victim of a tort committed in the conduct of the business enterprise. For example, a pedestrian
hit by a van used by a courier business would not be a voluntary claimant. The pedestrian could
not choose to be hit by a van used in the particular courier business as opposed to some other
courier business and would not have the opportunity to charge the business in advance to
compensate for the risk of being hit by the courier business’ van.

1. Distributive Justice

The corporate entity may be disregarded in order to compensate a tort victim. In some situations
the assets of a corporation may not be sufficient to fully compensate the tort victim. One way to
deal with such inadequate compensation is to disregard the corporate entity and make persons
such as shareholders, directors, officers or employees personally liable to make up the shortfall
in compensation. Here the benefits of preserving limited liability may be surrendered to address
the distributive consequences of not fully compensating a tort victim.

2. Incentive Costs and Efficiency

The injury caused by the van might have been in part the result of something in control of the
managers of the courier business. For instance, they might have set up an incentive for drivers to
make speedy deliveries by paying the drivers on a per delivery basis. This could give the drivers
an incentive to drive too fast and recklessly thereby increasing the risk of injury causing
accidents. Imposing liability on the business enterprise could create an incentive to take this risk
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into account when devising a method for compensating drivers. The investors would have to pay
for the damages and would want the managers to devise a compensation method that took this
cost into account. However, if investor liability is limited to the amount of their investment there
is a potential for a so-called “sanction insufficiency” or “deterrence trap”. If investors have
invested only $1 million but the potential damages are $10,000,000 then the investors will not
have to cover the full damages. Since they do not bear the full $10,000,000 in damages they do
not have an incentive to cause managers to take the full cost into account in devising the driver
compensation mechanism.

One way of restoring the incentive effect of the full amount of the damages would be to override
the limited liability of investors in tort claims, but this could result in the loss of the benefits of
limited liability to society. There are other problems that would have to be addressed. For
instance, who should be liable, shareholders at the time of the accident, at the time of the action
was brought, or at the time judgment is rendered, etc.? Perhaps there are other ways to deal with
these concerns that do not result in the loss of efficiency benefits (e.g. more insurance or a
broader accident compensation scheme).

3. Piercing the Corporate Veil in Tort Cases

The concern for compensating tort victims may explain a somewhat greater willingness of courts
to pierce the corporate veil in tort cases. Wolfe v. Moir, discussed above, is an example of this.
However, courts do not automatically pierce the corporate veil in tort cases. The court did not
pierce the corporate veil in Walkovsky v. Carlton (although it was a 5-2 split decision). Making
Carlton personally liable here would presumably have provided greater compensation for
Walkovsky. Perhaps making Carlton personally liable would have encouraged persons in his
position to carry better insurance so that compensation would be provided to the persons who
were injured in the conduct of the cab business. However, there might be little incentive for a
relatively judgment proof person who owned two beat up old cabs to carry better insurance.
Perhaps what was required was a requirement for persons operating cab companies (or driving
cars) to carry much higher levels of insurance that the statute required.

IV. OTHER WAYS OF DISREGARDING THE CORPORATE ENTITY

Objective:

Be able to set out and apply other approaches to making individual shareholders or directors
liable for “corporate wrongdoing”.

A. Tort Action Against Directors, Officers or Employees

Since a corporation can only act through human beings, a tort committed by a corporation must
be committed by the act of one or more individuals. Thus instead of (or in addition to) suing the
corporation for the tort one might consider suing the individuals who did the acts that amounted
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to the tort. The corporation is vicariously liable for the tort if the individuals, acting as agents
for the corporation, committed the tort in the scope of their authority as agents (see chapter 3).
However, agents themselves can be liable for their tortious acts. The concern that has sometimes
been expressed in this context is that making an officer of the corporation liable (especially when
the officer is also a shareholder of the corporation) amounts to making “an end run around the
corporate veil”.

1. Case Examples and the “Said v. Butt Exception”

Berger v. Willowdale A.M.C. (1983), 145 D.L.R. (3d) 247

Ms. Berger worked for Falken Automobiles Inc. which had a car display area and a repair shop
on Young Street in Toronto. It was February and it was a week in which the weather in Toronto
couldn’t make up its mind on being winter or not. It had snowed. Then there was freezing rain
and the snow turned to slush. The weather got cold again and the slush froze. Mr. Falkenberg,
the president of Falken Automobiles Inc. had instructed certain employees to clear the ice from
the steps and the area in front of the establishment. The employees failed to do this and Mr.
Falkenberg did not follow up to ensure that the job had been done. It snowed again and now the
treacherous ice was concealed by a substantial layer of snow. When Ms. Berger left work on a
fateful day in February she slipped getting into the car at the street in front of the business
establishment.

As an employee the remedy for Ms. Berger was to make a worker’s compensation claim under
worker’s compensation legislation. Ms. Berger was not happy with the compensation she
received through worker’s compensation. She could not seek additional compensation from the
company because a tort action against the employer (the company) was precluded by the
legislation. Instead she sued Mr. Falkenberg. The first defence was that the Worker’s
Compensation Act precluded an action against either the employer or a fellow employee.
However, it was held that the Workers’ Compensation Act provision precluding an action against
a fellow employee did not apply to an executive officer of a corporation since and executive
officer was not an “employee” under the Act. It was held that it Falkenberg had a duty to make
sure the walkway was safe for the employees and was negligent in failing to see to it that the ice
was removed.

Said v. Butt [1920] 3 K.B. 497

In Said v. Butt [1920] 3 K.B. 497 there was a dispute between Mr. Said and Mr. Butt. Mr. Butt
was the managing director of the Palace Theatre Ltd. Mr. Said had made certain allegations
against Mr. Butt and other officials of the theatre concerning a light opera that was produced at
the threatre. These allegations were deeply resented by Mr. Butt and the theatre officials. Mr.
Said applied twice for tickets to the first performance of a new play at the theatre but the
application was refused. He sent Mr. Pollock to buy a ticket on his behalf. Mr. Pollock never
disclosed that he was buying a ticket for Said. On the evening of the first performance of the
play Butt saw Said in the vestibule of the theatre and gave instructions to the attendants that Said
was not to be allowed admission even if he had a ticket. They offered Said the money for his
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ticket but he refused to take the money. Mr. Said brought an action against Mr. Butt in tort for
the tort of inducing breach of contract.

Before getting to the key point of this case for our purposes here it is useful to examine what the
case said in terms of the doctrine of an undisclosed principal. McCardie J. noted that before a
breach of contract could be induced there had to be a contract. Was there a contract here? Mr.
Pollock did not disclose that he was acting for Mr. Said – Mr. Said was thus an undisclosed
principal. Normally an undisclosed principal can disclose the agency relationship and sue the
third party directly. However, this does not apply if it is clear that the third party would not have
contracted with the principal had they know the identity of the principal. Here it was clear that
the Palace Theatre Ltd. would not have contracted with Mr. Said had they known that Mr. Said
was the person on who’s behalf the ticket was being purchased. Thus there was no contract with
Mr. Said and Mr. Butt could not be liable for inducing a breach of a contract that did not exist.

It is useful to note the undisclosed agency basis for the decision to indicate that the important
words McCardie J. later wrote concerning the potential liability of officers of companies for
inducing breach of contract were obiter. McCardie J. said that,

“ … if a servant acting bona fide within the scope of his authority procures or causes the
breach of a contract between his employer and a third person, he does not thereby
become liable to an action of tort at the suit of the person whose contract has thereby
been broken.”

McCardie J. went on to say that,

“Nothing that I have said to-day is, I hope, inconsistent with the rule that a director or a
servant who actually takes part in or actually authorizes such torts as assault, trespass to
property, nuisance, or the like may be liable in damages as a joint participant in one of
such recognized heads of tortious wrong.”

In spite McCardie’s additional remarks, Said v. Butt was occasionally subsequently cited for the
broader proposition that directors or officers of corporations could not be liable for torts
committed when they were acting bona fide within the scope of their authority as agents for a
corporation. The McFadden case discussed below, itself a case of inducing breach of contract
but one in which the officers of the corporation were found personally liable, discussed the Said
v. Butt exception as an exception based on directors, officers or employees acting bona fide
within the scope of their duty. This broader interpretation was questioned more recently by the
Ontario Court of Appeal in ADGA Systems International Ltd. v. Valcom, also discussed below.

McFadden v. 481782 Ont. Ltd. (1984), 47 O.R. (2d) 134

In McFadden v. 481782 Ont. Ltd. (1984), 47 O.R. (2d) 134 the plaintiff, McFadden was
employed by Practical Management Associates Inc. (“PMAI”), a U.S. corporation. The
employment contract was for a fixed term until July 1, 1982, and thereafter was terminable on 60
days’ notice. On June 1, 1981, Norman and Mary Taylor, his wife, incorporated Practical
Management Associates (Canada) Inc. (“PMAC”) under the Ontario Business Corporations Act,
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which later changed its name to 481782 Ontario Limited. PMAC bought the Canadian business
of PMAI and continued to employ McFadden under the terms of his contract with PMAC. The
business assets were later sold back to PMAI except for accounts receivable from upcoming
services to be provided by PMAC. After the accounts receivable were taken in the remaining
funds in PMAC were withdrawn as salary or dividends in favour of Norman and Mary Taylor.
McFadden was dismissed April 5, 1982. Further funds were withdrawn from PMAC over the
course of the next three days rendering PMAC insolvent. Norman and Mary Taylor were held
personally liable for the tort of inducing breach of contract.

Callon J. noted the exception in Said v. Butt and had this to say about it:

“I have some difficulty with the rationale offered for the decision in Said v. Butt … in
Winfield’s Law of Torts … The fact that the agent is an alter ego of the corporation may
afford a defence to the corporation (since it makes no sense to sue it for both breaching
and inducing itself to breach a contract), but it is not clear why that should relieve the
agent. For as a general rule, an agent is always liable personally for his tortious acts,
notwithstanding that his acts (and hence his liability) may in law also be those of the
corporation … And it is also accepted that a principal may be relieved of liability for the
tortious act of his agent, where the act is outside the agent’s scope of authority, real or
implied -- though the agent himself remains liable ...
It appears to me that the real reason for relieving the agent of liability lies instead in the
realm of justification, inasmuch as an act of inducement may be excused if there is
“sufficient justification”… And it is clear that under both statute and common law a
director or officer of a company is under a duty to act with a view to the best interests of
the company. Acts of inducement are justified where they are “taken as a duty”.
In short, if an officer or director of a corporation is to be relieved, as an agent, of the
consequences of his otherwise tortious act of inducement, it is not because he is the
company’s alter ego. Rather, it is because in so acting he acts under the compulsion of a
duty to the corporation. His act is thus justified. But where he does not act under such a
duty, as, for example, where he fails to act bona fide within the scope of his authority, his
act is no longer justified, and he becomes liable. The corporation remains insulated from
the legal consequences of such an act, inasmuch as the director or officer has acted
outside the scope of his authority.
Thus if it could be said that in acting as they did Norman and Mary Taylor were acting in
furtherance of their duties and obligations as directors and officers of PMAC, then they
would have available to them the defence of justification for any breach of contract they
induced. But in procuring and inducing the breach of the plaintiff’s contract with PMAC,
they were not acting in furtherance of any such duties and obligations.”

ADGA Systems International Ltd. v. Valcom Ltd. (1999), 43 O.R. (3d) 101

In the recent case of ADGA Systems International Ltd. v. Valcom Ltd. (1999), 43 O.R. (3d) 101
the Ontario Court of Appeal reviewed the so-called Said v. Butt exception to the liability of
officers. ADGA brought an action against its competitor Valcom Ltd. ADGA had a contract
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with Correctional Services Canada for technical support and maintenance of security systems in
federal prisons. The contract was up for renewal in 1991. The tender required the tendering
party to provide the names of 25 senior technicians. ADGA had 45 such employees while
Valcom had none. Valcom’s sole director and two of its senior employees convinced senior
employees of ADGA to allow their names to be used on Valcom’s tendering document, to come
to work for Valcom if their tender were successful and to convince other ADGA employees to
do the same. All but one of the 45 ADGA employees signed on with Valcom. ADGA sought
damages against Valcom and its director and senior employees on the basis of, among other
things, the tort of inducing breach of contract.

The judgment of the court was delivered by Carthy, J.A. who quoted the statements of McCardie
J. in Said v. Butt noted above and then commented as follows:

“For present purposes, I extract the following from McCardie J.’s reasons. First, this is
not an application of Salomon. That case is not mentioned anywhere in the reasons.
Second it provides an exception to the general rule that persons are responsible for their
own conduct. That exception has since gained acceptance because it assures that persons
who deal with a limited company and accept the imposition of limited liability will not
have available to them both a claim for breach of contract against a company and a claim
for tortious conduct against the director with damages assessed on a different basis. The
exception also assures that officers and directors, in the process of carrying on business,
are capable of directing that a contract of employment be terminated or that a business
contract not be performed on the assumed basis that the company’s best interest is to pay
damages for failure to perform. By carving out the exception for these policy reasons,
the court has emphasized and left intact the general liability of any individual for
personal conduct.”

Carthy, J.A. then cited cases, including Berger v. Willodale A.M.C., in which an officer or
employee was held liable for tortious conduct in carrying out duties on behalf of the company.
Carthy, J.A. then explained the development of the cases in the following way,

“Although the jurisprudence on this subject has followed a very straight path since the
decisions in Salomon v. Salomon and Said v. Butt, in recent years in this jurisdiction
judges hearing motions to dismiss claims have tended to smudge these principles,
inspired, in my view, and as expressed by them, by the legitimate concern as to the
number of cases in which employees, officers and directors are joined for questionable
purposes. The assumption has filtered into reasons for judgment that the employee is
absolved if acting in the interests of the corporation, the employer, even in cases that do
not raise the Said v. Butt defence.”

Carthy, J.A. also noted the distinction drawn by LaForest, J. in the Supreme Court of Canada
case of London Drugs v. Kuehne & Nagel between voluntary claimants (i.e. those that had dealt
with the company), who have in some manner accepted that their recourse would be to the
company only, and involuntary claimants who have not implicitly accepted that their recourse
would be limited to the company and who “naturally look for liability to the persons who have
caused the harm”.
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Carthy, J.A. then concluded that,

“… there is no principled basis for protecting the director and employees of Valcom from
liability for their alleged conduct on the basis that such conduct was in pursuance of the
interests of the corporation. It may be that for policy reasons the law as to the allocation
of responsibility for tortious conduct should be adjusted to provide some protection to
employees where, for instance, they are acting in the best interests of the corporation with
parties who have voluntarily chosen to accept the ambit of risk of a limited liability
company. However, the creation of such a policy should not evolve from the facts of this
case where the alleged conduct was intentional and the only relationship between the
corporate parties was as competitors.”

ADGA Systems thus appears to limit the Said v. Butt exception to cases involving the tort of
inducing breach of contract. The reason for this is that in the tort of inducing breach of contract
the plaintiff would have a claim for damages against the corporation for breach of contract and a
claim for damages again against the directors, officers or employees responsible for inducing the
breach of contract. This problem would arise in every case of a breach of contract by a
corporation since the decision to breach would have to have been made by one or more
individuals on behalf of the corporation. While the court may be able to deal with the potential
for double compensation in some way it would still be left with the problem that the damages for
each claim are calculated on a different basis. The plaintiff in these cases would also have dealt
with the corporation in entering into the contract and thus, subject to potential misrepresentation
problems discussed above, should have appreciated that it was dealing with a corporation and
that its claim would be limited to the assets of the corporation. There may be other situations in
which voluntary tort claimants tort claims against directors, officers or employees should be
constrained, but Carthy J.A. was unwilling to expand on these until a specific fact situation arose
in which to assess whether such protection should be extended.

The ADGA Systems case prompted a lot of comment. It raised the spectre of potential substantial
tort liability for directors, officers and employees. Two recent B.C. cases, while citing ADGA,
follow a much narrower principle. In Rafiki Properties Ltd. v. Integrated Housing Development
Ltd. (1999), 45 B.C.L.R. (2d) 316 Rafiki Properties Ltd. had contracted with Integrated for
development management services in the development and construction of a hotel. Rafiki
alleged that it relied to its detriment on false representations of Integrated and its two principles
(who were the only shareholders, directors and officers of Integrated). Clancy J. adopted the
principle set out in an earlier B.C. case that a director “can only attract personal liability if he is
acting outside the scope of his authority in being motivated by advancing a personal interest
contrary to the interests of the company, or by fraud, or with malice.” In Better Off Dead
Productions Ltd. v. Pendulum Pictures (2002), 22 B.L.R. (3d) 122 (B.C.S.C.) Better Off Dead
claimed they relied on misrepresentations in advancing funds to Pendulum Pictures and extended
the claim to the president of Pendulum. The president sought to have the claim against him
personally dismissed. Holmes J. dismissed Better Off Dead’s claim against the president of
Pendulum saying,
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“I find nothing to distinguish the situation here from that addressed by Clancy J. in Rafiki
Properties Ltd. … Clancy J. reviewed the authorities, including the Ontario Court of
Appeal’s decision in ADGA Systems … which recognized some scope for the individual
liability of directors and officers for tortious conduct even when committed in the course
of their duty. [Clancy J.] concluded … that an individual defendant will bear personal
liability for acts committed on behalf of a company only where the torts are those of the
individual and the allegations show an identity or interest separate from that of the
company.”

2. Some Policy Considerations in Making Directors, Officers or Employees Personally


Liable for Torts Committed in Carrying on the Business of the Corporation

Making directors, officers and employees personally liable for their tortious conduct in the
carrying on of the business of the corporation could overcome the “deterrence trap” or “sanction
insufficiency” problem (discussed in part III E 2 above) and restore the incentive to take
sufficient care. However, this could lead to excessive deterrence with managers emptying the
coffers of the business enterprise at the expense of investors to protect themselves from liability.
This potential for excessive deterrence could be controlled by indemnifying the directors and
officers for liability they incur and through the purchase of insurance. The costs of the
indemnification and insurance would be born by the business entity without extending the
liability of investors beyond the amount of their investment. With directors and officers
protected from personal liability through indemnification and insurance they would no longer
have an incentive to waste corporate assets to protect themselves against personal liability. The
costs of indemnification and insurance could then be reflected in the prices for the goods or
services provided by the business enterprise so that consumers bear the full cost of harm
prevention or compensation that production of those goods or services entails.

Difficulties with an insurance solution to the problem of compensation have arisen in the past.
Burgeoning tort liability in the 1980s led to uncertainty about the potential scope of liability.
This made it harder for insurers to predict claims and thus harder to price insurance coverage.
This, coupled with regulatory difficulties in setting adequate premiums for insurance associated
with these uncertain levels of loss, led to the absence of insurance for various types of losses.
For instance, it was difficult to obtain insurance for environmental losses. An insurance crisis
could limit the effectiveness of insurance at balancing deterrence and excessive deterrence.
However, the solution to this problem probably rests in insurance regulation to reduce the
likelihood of an insurance crisis rather than in refusing to make directors and officers (the so-
called “gatekeepers”) personally liable for their tortious acts.

B. Use of Corporate Oppression Action

It may also be possible in some cases to make director or officers liable on the basis of an
oppression application. Section 241 of the CBCA allows the court to make an order for relief on
the basis that the conduct of the affairs of the corporation has been oppressive or unfairly
prejudicial to, or that unfairly disregarded the interests of, a “complainant” in the
“complainant’s” capacity as a “security holder, creditor, director or officer”. In section 241(3)
the court is given wide powers for providing relief including, in s. 241(3)(j), the power to make
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“an order compensating an aggrieved person.” The court might then make an order for
compensation against a particular director or officer of the corporation. This was done, for
example, in PCM Construction Control Consultants Ltd. v. Heeger, [1989] 5 W.W.R. 598. The
plaintiff was held to have been wrongfully dismissed. The corporation, however, had been
reduced to a mere shell corporation (not unlike the McFadden case above). The plaintiff was a
shareholder and director of the corporation. In addition to the wrongful dismissal the court held
that there were various oppressive acts and applied the ABCA equivalent of CBCA s. 241(3)(j)
(an order compensating an aggrieved person) ordering the other directors of the corporation to
compensate the plaintiff.

V. STATUTORY PROVISIONS UNDER WHICH SEPARATE CORPORATE


PERSONALITY AVOIDED

A. CBCA s. 118

Although the corporation is a separate person from its directors, directors of a CBCA corporation
may be held liable for certain corporate acts. CBCA s. 118 sets out a number of circumstances
in which directors may be found personally liable. Under s. 118(1) directors can be liable for
issuing shares without receiving full payment for the shares. Under s. 118(2) directors can be
liable for purchasing, redeeming or otherwise acquiring shares, paying commissions for the sale
of shares, paying dividends, providing financial assistance to shareholders, directors, officers or
employees, or for paying an indemnity to a director or officer if certain tests of insolvency are
not satisfied. Even though shareholders are separate persons from the corporation they can be
held liable under s. 118(4) to indemnify a director who has been held liable under s. 118(2)
where they have been recipients of any of the funds paid out pursuant to a resolution of the
directors contrary to the provisions listed in s. 118(2).

B. Unpaid Wages

When a corporation is in financial difficulties it may be unable to pay all of its liabilities as they
come due. In an effort to keep the business going management may decide not to pay certain
liabilities. One type of liability that they often decide not to pay is the payroll. Employees may
capitulate in this for fear of losing their jobs if the business goes under. If a claim were made by
employees against directors or officers for the unpaid wages, the directors or officers might well
defend by relying on the separate personality of the corporation saying that the employees’
contracts are with the corporation and their claim is solely a claim against the corporation.

This vulnerability of emplyees has been addressed in employment standards legislation and in
corporate legislation. CBCA s. 119 overrides any argument that the directors are not liable on
the basis that the employee contracts are with the separate corporate legal entity. It provides that
directors are jointly and severally liable to employees for up to six months of unpaid wages.
Section 96 of the B.C. Employment Standards Act provides similar protection for up to 2 months
of unpaid employee wages.
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This way of addressing unpaid employee wages when corporations are in insolvent
circumstances has led to problems. When the corporation is experiencing financial difficulties
directors, fearing the risk of personal liability, have resigned en masse leaving the corporation
with no one at the helm at a time when it can ill afford to be without a board of directors.
Resolutions of a board of directors may be required for decisions that might be made in the
context of attempting to restore the company to financial viability. Perhaps other mechanisms of
protecting employees against unpaid wages should be considered. One possibility that has been
suggested is to put them in a higher position on an insolvency, perhaps even ahead of secured
creditors.

VI. OTHER STAKEHOLDERS AFFECTED BY LIMITED LIABILITY AND


PIERCING THE CORPORATE VEIL

Other stakeholders may be affected by the limited liability of the corporation. They may end up
with unsatisfied claims and may not have appreciated the significance of the limited liability
status of the corporation when they dealt with it. For instance, customers may have warranty
claims which will not have matured into full claims at the date of bankruptcy. If the corporation
becomes insolvent the benefit of the warranty will be lost (i.e. its value drops to zero).
Employees may also have built up their skills or abilities (human capital) in the business and can
not achieve nearly as high a wage in other businesses. If the corpration becomes insolvent they
suffer a loss. There is no recognition of this loss in bankruptcy proceedings. Should such losses
be compensated? Should they be compensated by disregarding the corporate entity and making
shareholders personally liable?

VII. GENERAL THEORY FOR THE DISREGARD OF THE CORPORATE ENTITY

The arguments concerning the benefits of limited liability that were discussed in chapter 10 were
made in articles that were directed at developing a theory of corporate veil piercing. The theory
is briefly summarized here.

A. Voluntary Relationships - Consensual Claimants

The theory discussed in the articles concerning voluntary relationships is the basis of the part on
categorizations of cases noted above and the policy reasons given above for the piercing the
corporate veil in those situations. The reasons are just briefly reiterated here.

1. Avoid Costs of Transacting Around Avoidance of Liability

The categories noted above included gap filling in contracts. Piercing the corporate veil in these
cases, as noted in Part III above, may avoid transactions costs associated with entering into
contracts that may arise if the parties had to anticipate every means of using a corporation to
avoid the contractual requirements and then negotiate and draft written contractual terms to
address those potential avoidance techniques.
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Similarly, piercing the corporate veil to prevent avoidance of statutory requirements may avoid
the costs associated with anticipating every means of using a corporation to avoid statutory
requirements and then drafting provisions (potentially very complex provisions) that prevent
such avoidance techniques.

2. Avoid Costs of Gathering Information

The misrepresentation cases noted above may involve situations in which promoters of the
company could have avoided confusion or misconceptions at lower cost than the persons dealing
with the company. If the promoters were not made liable in these situations then the outsiders
dealing with the company would have to be much more careful to make sure they knew exactly
who they were dealing with. In the case of a sole proprietorship or partnership business
outsiders would have to check every time they dealt with the business to make sure that it was
still being run as a sole proprietorship or partnership and had not been transferred to a
corporation. Such assessments are presumably much more expensive for outsiders than they are
for promoters who should know or have ready access to information concerning the exact nature
of form of organization under which the business is being carried on.

B. Involuntary or Non-Consensual Claimants

In the case of tort claims, a claim against a corporation may lead to insufficient compensation
where the appropriate compensation is greater than the assets of the corporation. The unsatisfied
compensation is arguably a cost of allowing limited liability. Where this cost is likely to be
greater than the benefits of limited then it would seem to make sense from the standpoint of
overall social welfare to make an exception to limited liability.

1. More Likely to Pierce in One-Person or Few Shareholder Companies

Where there is only one or very few shareholders the costs imposed by limited liability are likely
to outweigh any benefits of limited. As noted in chapter 10, the benefits of limited liability,
particularly the valuations costs and monitoring costs, increase with the number of shareholders.
Where there is just one shareholder limited liability does not reduce monitoring costs or
valuation costs at all relative to unlimited liability. Where there are very few shareholders the
savings of limited liability in terms of monitoring costs and valuations costs are likely to be
small. Thus courts may be more willing to pierce the corporate veil where there is just one
shareholder or where there are relatively few shareholders.

2. More Likely to Pierce Where it Leads to Claim Against Limited Liability Parent Co.
Rather than Shareholders

The literature on the benefits of limited liability also suggests a reason for the apparent greater
willingness of courts to pierce the corporate veil between affiliated corporations. Piercing the
corporate veil between affiliated corporations does not make any individual shareholders liable.
Thus no individual shareholder loses the benefits of diversification. With the benefits of
diversification still intact there should be no impact from piercing the corporate veil between
affiliated corporations on optimal management decision making (i.e. they should still make
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decisions without taking into account diverisifiable risk). Since individual investors will not be
made personally liable there will be no need for any individual investor to seek indemnification
from fellow investors or make sure that fellow investors can bear their share of any losses
imposed on individual shareholders. Thus there will be no need to incur costs to check on the
wealth of fellow investors before purchasing a share or monitoring or controlling the wealth of
one’s fellow shareholders after the purchase of shares. Since an investor would not have to
check the wealth of fellow shareholders before making an investment the price paid by the
investor would still impound information about the value of the investment. In short, the
benefits of limited liability would not be lost as a result of piercing the corporate veil between
affiliated corporations.