Legal News & Analysis – Asia Pacific – Hong Kong – Corporate/M&A 

 

At the recent briefing Present Company Excepted? The Modern Approach to Piercing the Corporate Veil, Gareth Thomas and Richard Norridge discussed the issue of piercing the corporate veil in light of the UK Supreme Court case of Prest v Petrodel Resources Limited.

 

1. The Corporate Veil

 

The term ‘corporate veil’ describes the distinct legal personalities of a company and its shareholders, a result of which is that a judgment against a shareholder is not usually capable of being enforced against the company‘s assets, and vice versa.

 

This issue typically arises in the context of a Plaintiff seeking to enforce a judgement against a Defendant who unexpectedly appears not to hold legal title to various assets, or whose sole assets comprise shares in companies in jurisdictions which tend not to give effect to the orders of foreign courts. This is becoming increasingly significant in the context of divorce proceedings in which one of the spouses does not engage in the court process in any meaningful sense.

 

Prior to the judgment in Prest, it was unclear exactly when the corporate veil would be pierced.

 

2. Prest v Petrodel Resources

 

In Prest, the husband was the sole owner of a number of offshore companies which collectively formed the Petrodel Group. Two of the companies, PRL and Vermont, owned properties in the UK:

 

1. PRL purchased three properties for nominal consideration (one from the husband, one from his brother, and one from the wife);
2. PRL purchased two properties for substantial consideration (one from the husband and one from the wife); and
3. Vermont purchased two properties for substantial consideration (from third parties).

 

At first instance, Moylan J ordered the husband to procure the transfer of the UK properties to the wife, and ordered the companies themselves to execute any transfer documents. This order was made on the basis of the Matrimonial Causes Act, which allows orders to be made in respect of property to which a party is “entitled”, given that the Petrodel group structure had been set up before divorce proceedings for tax reasons, and was not therefore improper. The Court of Appeal reversed Moylan J’s decision on the basis that the Matrimonial Causes Act had been interpreted far too broadly, and the concept of being “entitled” to property did not extend to the property of a company in which a party holds shares.

 

On appeal, the Supreme Court agreed that the Matrimonial Causes Act did not apply, but it nevertheless ordered that the properties be transferred to the wife, on the basis that they were held on trust by PRL and Vermont for the husband. In category (1), consideration was nominal, raising a presumption of ‘resulting trust,’ such that the husband retained a beneficial interest in the property transferred. In categories (2) and (3) the court found that the husband had provided the funds for the purchases, again raising the same presumption.

 

In reaching its judgment, the Supreme Court highlighted the difference between ‘concealment’ and ‘evasion’. Concealment refers to an attempt to disguise ownership of assets, for example through trusts, but does not change the fact that (beneficial) ownership is retained by the beneficiary. Evasion involves transferring absolute ownership of property to a third party so as to frustrate any attempt to enforce a claim against those assets. It will not apply where ownership has been transferred for bona fide reasons, and true evasion cases are likely to be rare.

 

3. Prest In The Criminal Context

 

Although only a recent decision, Prest has already been applied in the UK case of R v Sale, which involved the bribery of an employee of Network Rail, the UK‘’s rail operator, to award contracts to the Defendant’’s company. In deciding whether money paid to the company should be confiscated (as opposed to the benefit received by the Defendant personally) the English Court of Appeal held that the evasion principle would not apply, since the company had not been set up in order to evade any particular legal obligation. However the effect of the Proceeds of Crime Act was that gains made in certain criminal contexts could be treated as though falling within the concealment category. Consequently, the profit gained by the company could be subject to the relevant order.

 

4. Prest In Hong Kong

 

The Hong Kong Courts too have applied Prest. In the recent Hong Kong case of SLA née S v HKL, the Court described Prest as “persuasive authority of the highest order”. This case concerned the distribution of assets between a husband and wife, the main point of dispute focussing on any funds held by a company, L&H, through which the husband offered his services as an agent to various manufacturing firms.

 

The husband initially owned 90% shares in L&H directly, the remaining 10% being held through a second company, CS, which was wholly owned by him. Several months after separating, the husband and CS signed declarations of trust over the shares in favour of a business acquaintance, Mr C, and transferred the legal interest in the shares two years later. This transfer was made in return for a small sum of money (no valuation of the shares having taken place) and an agreement that the husband would stay on as an employee on a low salary. After 18 months, Mr C transferred the shares to a further mutual business acquaintance, Mr L.

 

The husband’s actions were described as characteristic of someone in control of L&H, such as claiming large travel expenses from the company and receiving his credit card bills at the Company’’s office. Furthermore, he continued to use the company email address even after he claimed to have stopped working there. On these facts, Carlson DJ found that any assets belonging to the company were held on trust for the husband, and the latter’’s transfer of his shares in L&H to Mr C (and onwards to Mr L) was “a sham“. The court held that “Mr C and Mr L and any subsequent corporate entity or individual will take any transfer of the shares by Messrs C and L to them impressed with that trust”.

 

The court found that L&H held its funds on trust for the husband and that these formed part of the husband’’s assets, but concluded that it could not impose concurrent liability on L&H due to Prest. The court’s basis for doing so was that, through his beneficial ownership of the shares in L&H, he was also beneficial owner of the assets. This is hard to reconcile with Prest, failing any finding of evasion. Although the judgment did not go into this in detail, the finding that the transfer of shares was a sham could have simply led to the shares being returned to the name of the husband and a receiver appointed over those shares if necessary (subject to any issues arising from the law of incorporation of the company). This judgment therefore demonstrates the kind of difficulties arising in establishing precisely how Prest will be applied in practice, and it is to be hoped that these will be dealt with in future judgments.

 

 

For further information, please contact:

 

Mark Johnson, Partner, Herbert Smith Freehills
[email protected]

 

Gareth Thomas, Partner, Herbert Smith Freehills
[email protected]

 

Richard Norridge, Herbert Smith Freehills
[email protected]

 

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