Law assignment - Critiques on the Concept of ‘Veil of Incorporation’ and Solving the Problem on ‘Competition Law' (Australian law)

Task description & requirements
Question 1:
“The concept of separate legal entity is often referred to as the ‘veil of incorporation’ — that is, the
shareholders and the directors are completely separate and distinct from the company as though a veil
hides and separates them. In exceptional cases the courts may lift this ‘veil of incorporation’ and give
rights and obligations to parties who would not otherwise have those rights and obligations…”
Gibson, A & Fraser D 2016, Business law, 9th edn, Pearson, Melbourne, p 546
What instances can the veil of incorporation be lifted? Provide case law examples to illustrate your
answer. [15 Marks]
Question 2:
Kim, a chef from South Korea, is working in a newly-opened Korean restaurant “Sorabol” in Launceston.
A clause in his employment agreement with Sorabol states: “The employee hereby agrees with the
employer, Sorabol Restaurant of Launceston, that he will not work as a chef in any Korean restaurant in
Australia for the period of six years after leaving the employment of Sorabol. He also warrants that he
will not operate or own any Korean restaurant in any place in Tasmania or in any Eastern State of
Australia”. Kim is now considering resigning from Sorabol as he is planning to move to Adelaide with his
girlfriend from Thailand and he is planning to establish a Korean restaurant in Adelaide. He is seeking
your advice as his friend whether he can set up a Korean restaurant in Adelaide without being in breach
of his service agreement with his current employer, Sorabol, in Launceston.
Advise Kim whether he is likely to be in breach of his service agreement with Sorabol. [15 Marks]

Note:
- Adopt IRAC approach*
- Demonstrate sound awareness of the concept of “Veil of Incorporation” and exceptions to it
as shown in case law. Demonstrate excellent awareness of case laws and ability to use cases
to support analysis.
- Demonstrated sound awareness of factors used in determining the validity / enforceability of
the restraint of trade clause in employment contract and demonstrated excellent awareness
of case laws and excellent ability to use such case laws to support analysis.

Question No. 1

1.     Introduction

The following essay is going to assess the veil of incorporation law with the help of the cases where veil of incorporation was lifted and the reason behind the lift. A long while back, it was agreed that the corporation will be considered as a separate entity from their owners, directors or even shareholders, this was titled as veil of incorporation law. In this law, it is assumed that the acts of corporation are not the actions of the owners of the corporation and owners are separated from any liability for the actions of the corporation (Garner, 2001). Corporation will have its own artificial life. It can buy properties, become a party to the contract, can become answerable to debts, violate rules and it can even be sued. Furthremore, if a corporate company acts against the law and the judgement comes against the corporation then the veil which is saving the owners of the corporation can be lifted and the people responsible for that must be held responsible and must give the penalty (Bello, and Michael, 2014).

2.     Discussion

Veil of incorporation law has been uncensored in the Australian corporate law for more than one hundred years. If a company is involved in any misconduct, then, only the company is answerable for those actions , the owners or controllers of the corporate company have no liability for the actions of the company. Besides that, there have been some occasions when courts have demolished the veil of corporation for making the shareholders liable for the actions of the corporation. This can happen when the offense is huge and can not be sorted otherwise or when the company or shareholder themselves asks the court to pierce the corporate veil (Ramsay and Noakes, 2001).

2.1.  Reasons of piercing the veil of incorporation

There are a number of factors due to which an Australian court might opt for piercing the corporate veil. Most common grounds for lifting the veil in Australia are: agency, fraud, group enterprises, trust, criminal, statute etc. (Ramsay, and Stapledon, 2001). The report is going to disucss some of those reasons along with the example cases. Factors are:

a)     Agency

b)     Fraud

c)     Undercapitalization

d)     Unfairness/justice

2.1.1.                    Agency

Aency is a contract or relationship  between two parties, where one party, known as principal,  is providing authority for another party, which is known as the agent, to act on their behalf. In such a case, if an agency is not abiding by the laws then the veil may be lifted and the company as well as the shareholders will be liable for the actions of the agency  (Saxena, 2010).

An example of such case in Australian corporate law is Spreag v Paerson Pty Ltd, where parent company was held responsible for the breaches of terms of the contract between agency and the company. Paerson was not having any assets, account books or documentation and it was found that they are acting as a subsidiary for Componore. Hence, in such situation the veil of the Componore was lifted and court held the company liable for the actions of Paerson. Australian Law states that agency is a valid reason for piercing the corporate veil but there have been some cases which needs more investigation than the fact that it is the agency of a parent company (Tham, 2014).

2.1.2.                    Fraud

When the controller of a company is reported use the corporation for deceptive acts, concealing the truth or is acting against the legal obligation, then this phenomena is termed as fraud. In the common law, whenever a corporate is found in the acts of fraud then their veil will be lifted and judgement will be given accordingly (Vandekerckhove, 2007). Australian courts will lift the corporate veil if the company was formed or used for conducting fraud acitivites. Although it is necessary for the act of fraud that it must be proved on the basis of sham or façade. Sham states that a company is formed for hiding the real purpose of the corporate, which is more likely to be against the law (Kluver, 2004).

As Ramsay and Noakes (2001) stated, one of the prominent cases of Australi regarding fraud was of Re Neo, the Immigrant Review Tribunal had to review a decision of the refusal of visa application where sponsorship was given by the company, which was formed on the same day as the submission of the application of visa and that company did not conducted any business. In a case like this, company was found to be fraud and it was established that the company was only a façade for allowing non-Austalians to remain in the country.

2.1.3.                    Undercapitalization

There are three variables of undercapitalization: 1. Not enough to start a business , 2. Funds are being drained, 3. Sum of both. Most courts consider the third variable for judging a company on the basis of undercapitalization. Some academics like, Jinweir Feng and Xianchu Zhang argue that for saving the creditors of the corporate courts is willing to lift the corporate veil on the basis of undercapitalization (Wu, 2007). In a study conducted by Milton (2006), he observed that the 77.3% of cases having insufficient funds were pierced by the couts and only 22.% of such cases were not pierced. Moreover, the companies having sufficient funds were not pierced , only 7.5 percent of cases, in which companies were having significant funding were pierced.

2.1.4.                    Unfairness/Onjustice

There are times when judge orders to life the corporate veil for the purpose of making a fair and just decision. There was one case when coporate plaintiff company and Mr Lo Surdo, the shareholder of the company, both were sued for the losses of contracters, who were in contract with plaintiff. In this case weil was lifted and investigations were conducted and it was concluded that Mr Lo had no obligations in this case. The company, as a separate entity was ordered to pay millions of dollars as a penalty (Ramsay and Noakes, 2001).

3.     Conclusion

Ramsay and Noakes (2001) stated that there are various factors due to which a court might consider piercing the corporate veil of the company. The majority of the cases of the piercing of the corporate companies occur when a company itself seeks to lift the veil. Moreover, the most common factor in lifting the corporate veil for Australian companies was of agency.

Question No. 2:

1.     Facts

First and foremost, the facts that are as explained in the report are the agreement of the restriction clause i.e. Kim who has been the employee would not be working as a chef (predefined designation) in any other Korean restaurant (predefined business) after the ending of the employment from Sorabol restaurant (employer) for six years (predefined period) in Australia (predefined place) has been signed by both the parties. Secondly, the warranty of not establishing or operating a Korean restaurant (predefined business) in Tasmania or in any Eastern State of Australia (predefined place), has been given by Kim (employee). Lastly, the fact would be that the planning of resigning from Sorabol (current employer) and establishing a Korean restaurant in a settlement of Australia i.e. Adelaide.

2.     Issues

The problem identified in this case assignment has been the restriction of employment and competition in a predefined place. Moreover, there has been an employer i.e. Sorabol restaurant that had an issue of competition and employment like if the employees of the restaurant works or own any other relevant business then there might be an issues of increased competition, replication of recipes, and the SOPs used in the restaurant. However, there has been an employee named Kim who had planned to resign from Sorabol and set up his own business i.e. a Korean restaurant in Adelaide but the issue would be the agreement he had signed with Sorabol . He had been in a deep dilemma to decide whether to go ahead or not. In addition, the area of law that would govern the decision of this problem would be the restraint of trade clause under the Employment law.

3.     Rules or Relevant Law

The legal principles that would be used to tackle this problem would be the factors for the enforceability and validity of restraint to trade clause that would come under the Employment law. More specifically, the non – compete clause and its enforceability and validity factors would be studied to solve this problem. Moreover, the reason of choosing this clause has been the relevancy of the clause with the current problem as it prevents an individual from competing with its former employer for a particular span of time (Butlers Lawyers, 2017). The legal principle could be taken from the case of Buckley v Tutty (1971) 125 CLR 353 at 380 in which the high court of Australia stated that the enforceability of unreasonable constraints are not valid and it has been seen as contrary to public welfare as it has been preventing someone from earning a living (Jewell, 2018). However, in another case of Southern Cross Computer Systems Pty Ltd v Palmer (No 2), the Victorian Supreme Court prevented an IT professional from working for a competitor as sale of shares were included in it. Moreover, there were many different factors that has been taken into account such as the restraint period, the designation of the employee, the geographical location, the intensity of the confidentiality and the amount given to the employee after the resignation, etc (Butlers Lawyers, 2017).

4.     Application

As per the study of the Employment law and the relevant precedent cases the restriction by Sorabol from working as a Chef in any other Korean restaurant for six years in Australia could be enforceable and Kim will have to face consequences if he breaches it. The reason behind its enforceability would be the confidentiality as the restaurant business has been fully dependent on the recipes and taste it offers and if Kim started working in any other Korean restaurant in Australia then there would be a replication of taste and recipes that would decrease Sorabol revenue and value, and increase competition with a wrong means. Nevertheless, the similar act happened in the case of Southern Cross Computer Systems Pty Ltd v Palmer (No 2), where the judge prevented the IT specialist from working for the competitors for a predefined period. Moreover, the enforceability also depends on the amount of money given by Sorabol to Kim because if it’s restricting him to work somewhere else then it should be providing a handsome amount of money to fulfill his living (Butlers Lawyers, 2017). Secondly, the warranty given by Kim to Sorabol had not been valid or enforceable as he had been planning to start a Korean restaurant in Adelaide that has been in the South Australia and the warranty was for Tasmania and other Eastern states of Australia. However, Kim could establish a Korean restaurant in Adelaide as no clause was mentioned in the agreement about this location by Sorabol. On the other hand, according to the statement of Australian high court in the case of Buckley v Tutty (1971) 125 CLR 353 at 380 it has not been enforceable to restrict someone from earning a living (Jewell, 2018) and an employer can not restrict an employee from starting a new business in the states of Australia in which the employer has not been operating that was mentioned in the case of Southern Cross Computer Systems Pty Ltd v Palmer (No 2) (Butlers Lawyers, 2017).

5.     Conclusion

As per the writer’s understanding and observation, Kim would not be in any breach of service agreement with his current employer Sorabol as he has not been employed as a Chef in any of the Korean restaurant in Australia so he has been not breaching the employment clause at all. However, as far as the ownership and operations clause is being concerned, it was clearly warranted by Kim to Sorabol that he would not be operating or starting a Korean restaurant in Tasmania or any Eastern state of Australia. However, he had been planning to establish a Korean restaurant in Adelaide which was situated in South Australia and as per the previous case Sorabol couldn’t restrict him from starting a new business all across Australia or in the areas in which they are not operating. So, it could be said that Kim had not been in any breach if he chose his current plan but he would face certain consequences if he would go for employment as Chef in any other Korean restaurant in Australia for the period of six years.

References

• Ballantyne Suites Pty Ltd v Ballantyne Chambers Pty Ltd (In Liq) (2014) VSCA 223.
• Bello, S.A. and Michael, O.C., 2014. Piercing the Veil of Business Incorporation: An Overview of what Warrants It. Review of Contemporary Business Research, pp.117-138.
• Butlers Lawyers. (2017). What is a reasonable restraint of trade clause?. [online] Available at: https://butlers.net.au/employment-update-restraint-trade-clause/ [Accessed 3 Sep. 2018].
• Garner, B.A., 2001. A dictionary of modern legal usage. Oxford University Press, USA.
• Jewell, A. (2018). Restraints of trade: non-compete clauses, are they reasonable?. [online] Seek Insights and Resources. Available at: https://insightsresources.seek.com.au/restraints-trade-non-compete-clauses-reasonable [Accessed 2 Sep. 2018].
• Kluver, J., 2004. Entity vs. Enterprise Liability: Issues for Australia. Conn. L. Rev., 37, p.765.
• Knutsson, P., 2018. Piercing the corporate veil: limits of limited liability.
• Milton, D., 2006. Piercing the corporate veil, financial responsibility, and the limits of limited liability. Emory LJ, 56, p.1305.
• Ramsay, I. and Noakes, D., 2001. Piercing the corporate veil in Australia.
• Ramsay, I. and Stapledon, G., 2001. Corporate groups in Australia.
• Saxena, H., 2010. Lifting of Corporate Veil.
• Tham, S.S., 2014. Piercing the corporate veil: Australia and China (Doctoral dissertation, Murdoch University).
• Vandekerckhove, K., 2007. Piercing the corporate veil. Eur. Company L., 4, p.191.
• Wu, M., 2007. Piercing China's Corporate Veil: Open Questions from the New Company Law. Yale LJ, 117, p.329.
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