Issue
The key issue is to ascertain if the director of a company can be personally held liable for negligent actions when employed by a company and also the outline the conditions under which this is permissible. Additionally, the concept of piercing the veil also needs to be discussed to determine if the shareholders can be personally held liable for the negligent actions done under the name of the company. In wake of the above issues, the key objective is to ascertain if ABL (Abe’s Farms Limited) can sue LCL (Lex Consulting Limited) or Lex in wake of the damage caused to the crop on account of his negligent actions.
Law
A company is a business structure which is unlike other business structures such as partnership owing to the fact that it has separate legal entity separate from the shareholders or owners. This position is acceptable in common law for more than a century. A landmark case in this regards is Salomon v A Salomon & Co Ltd where it was highlighted that the outstanding liabilities of the company cannot be settled by liquidating the personal assets of the shareholders as the two are separate legal entities. This position is also upheld by Section 15 of New Zealand Companies Act 1993.
As per the relevant facts of the Salomon v Salomon case, Salomon has a leather shoe business which was carried out as a sole proprietor. However, since his sons wanted stake in the business, hence he established a new company (i.e. A Salomon & Co Ltd) where more than 99% of the shares were held by Mr.Salomon and each of his sons had only 1 share. This company purchased the shoe business of Mr. Salomon by paying a premium to the market value of the business. Mr. Salomon provided some debt to the company owing to which debentures were issued. The business received significant orders from the government and had to face financial difficult when the government decided to diversify the suppliers. As a result, the financial situation of the company worsened and it eventually became unable to service the outstanding creditors. Before the bankruptcy, Mr, Salomon was able to sell the debentures. The outstanding creditors accused Mr; Salomon of using the company as a means to escape liability and hence demanded that Mr. Salomon should settle the unsettled creditors. However, it was ruled that company is a separate entity from the owner and irrespective of the ability of the shareholder to settle the outstanding liabilities of the company, this is not legally binding on the shareholder.
Clearly, the above protection extended by the company structure can potentially be abused by various unscrupulous agents who may register a company for conducting fraudulent activities. To address this issue, the concept of piercing the corporate veil has been since introduced whereby under some circumstances the court removes the protection offered by the company structure in order to indicate the true controller. A relevant case in this regards is Prest v Petrodel Resources Ltd . Lord Sumption indicated that the corporate veil may be pierced only when the objective is to derive the company or the underlying controller of the advantage that is obtained from the doctrine of separate personality of company. The corporate veil is typically pierced when fraudulent activities or conduct is displayed and the company structure has been formed with the purpose of escaping liability arising from such actions. This has been indicated in the Lazarus Estates Ltd v Beasley through the following statement made by Denning LJ.
“No court in this land will allow a person to keep an advantage which he has obtained by fraud. No judgment of a court, no order of a Minister, can be allowed to stand if it has been obtained by fraud. Fraud unravels everything. The court is careful not to find fraud unless it is distinctly pleaded and proved; but once it is proved, it vitiates judgments, contracts and all transactions whatsoever.”
Another pivotal aspect to be discussed is whether directors can be held personally liable in a one person company structure on account of negligent actions. The relevant case in this regards is Trevor Ivory Ltd v Anderson. In this case, the defendant (i.e. Trevor Ivory) provided negligent advice to a client in the course of normal business which caused loss to the client in the form of damaged crops. The court ruled that despite the negligent advice provided by the director (also the shareholders), he was not personally liable for the damages incurred by the client. It was indicated that if the underlying director would be made personally liable for all the actions under the name of the company, then the doctrine of limited liability would be violated in case of one man company. However, it was indicated that in certain cases, it is possible to hold the director personally responsible. This would include a situation where the visibility of the concerned person who is the director and shareholder is more than the company. Further, the indulgence of the concerned director in the act rather than advice would also strengthen the case for personal liability of director. Therefore, the personal liability of the directors would be driven by the individual case facts brought before the court.
Another relevant case which merits discussion in relation to personal liability of the directors in wake of negligence is Morton v Douglas Homes Ltd. A key principle highlighted by Hardie Boys J is that the limited liability doctrine in a company structure extends to the shareholders only and not to the directors as they have the responsibility in relation to various torts as is comparable with other agents or servants. In order to determine if a duty of care arises on the director, the extent of control of the director on the activities of the company would be considered. This is imperative so as to determine if any personal carelessness on the part of the concerned director may cause the damage to the client. The significance of this case stems from the fact that this has not been overturned still and thereby acts as a key legal precedent in New Zealand context.
The confusion in relation to underlying principle in the context of directors’ liability is caused by the verdict in the Body Corporate 202254 v Taylor. In this case, the Court of Appeal indicated that the appropriate approach in relation to ascertain the liability of directors in negligence is based on the element of tort. Further, while doing so, the court decided to extend special treatment to negligent misstatement especially in cases where the company director is the defendant. The application of different principles prescribed by the court while dealing with the subject of personal liability of directors has led to confusion. There is evident by comparison of the principle of assumption of responsibility and principle of degree of control. The former test is a threshold test where responsibility of directors in relation to the damage caused to the plaintiff needs to be ascertained before the elements of tort may be applied. On the contrary, the latter is a proximity test since negligence may be carried out by a subcontractor but on account of control over subcontractor, personal liability of the director would arise. As a result, while application of the legal precedents in relation to personal liability of directors, it is essential that the relevant case facts and circumstances ought to be considered so as to determine the appropriate approach applicable.
Application
Based on the given facts, it is apparent that there was negligence exhibit by Lex which was responsible for causing damage to the crops owing to which loss has been incurred by ABL. It is known that the spray was quite powerful and not the reason for the damage caused to the crops. The manner of application of the spray was not appropriate owing to which the crops were damaged. The advice in relation to application of the spray was offered by Lex who was into consulting regarding various sprays for agricultural purposes and has established a company named LCL for the same. In relation to the consulting services, there is a contract between ABL and LCL.
The fact that the advice offered by Lex was inappropriate has been clearly established. Clearly, the services provided were not appropriate and has caused damage to ABL owing to which ABL can sue LCL. This is because the company as a separate legal entity had a duty to care towards the client (ABL) which seems to have been violated resulting in losses by the client. The key question emerges is whether ABL can sue Lex as the sole shareholder in personal capacity for the damages. It is unlikely that this would be possible as doctrine of limited liability highlighted in Salomon v Salomon would apply. Further, there is no evidence to indicate that the company was formed by Lex in order to escape any existing liability at the time. Therefore, the damages related claim on behalf of ABL would extent only to the assets of LCL.
Another key aspect is to analyse if Lex can be held personally liable as the director of LCL. In this regards, it is essentially to refer to Trevor Ivory Ltd v Anderson case where it was indicated that in case the concerned individual was more prominent than the company, then that individual could be personally held responsible for the negligent actions. This is true here since Lex is known more than the company. Also, Lex was personally involved in the spraying of farm which further strengthens the chances of the court holding him personally liability.
Also, if the incident is approached through degree of control, then also it is apparent that Lex was the person who tendered the advice and hence had full control. Additionally, the presence of tort elements is evident. This is because as the agent of the company (LCL), there was a duty to care on Lex to safeguard the interests of then company and client. The advice offered is clearly negligent which implies breach of duty. Further a causal link may be established between the negligent advice and damage incurred by ABL. As a result, based on tort elements also, Lex would be held as personally liable.
Conclusion
On the basis of the above discussion, it may be concluded that ABL can sue LCL on account of negligence and poor services provided thereby leading to breach of contract. However, ABL can also hold Lex personally liable for the losses as he is the sole director of the company and possesses the requisite responsibility, control. Additionally, the elements of tort of negligence are also present in the given scenario.
Bibliography
Books & Websites
Susan Watson and Chris Noonan, “Th e corporate shield: What happens to directors when companies fail?” (2004) < https://www.uabr.auckland.ac.nz/files/articles/Volume11/v11i1-the-corporate-shield.pdf>
Victoria Stace, “DIRECTORS’ LIABILITY IN NEGLIGENCE – CHALLENGING THE “ELEMENTS OF THE TORT” APPROACH” (2016) < http://www.nzlii.org/nz/journals/VUWLawRw/2016/26.pdf>
Walker, Pekmezovic et al, Commercial Applications of Company Law in New Zealand (5th edition, CCH, Auckland 2015)
Cases
Body Corporate 202254 v Taylor [2009] 2 NZLR 17
Lazarus Estates Ltd v Beasley [1956] 1QB 702
Morton v Douglas Homes Ltd [1984] 2 NZLR 548
Prest v Petrodel Resources Ltd [2013] UKSC 34.
Salomon v A Salomon & Co Ltd [1897] AC 22
Trevor Ivory Ltd v Anderson [1992] 2 NZLR 517
Legislation
New Zealand Companies Act 1993
