Identify the problems for third parties which arise from the existence of the corporate veil
As per the separate legal entity principle, investors are not liable for the organization’s obligations past their underlying capital venture, and they do not have any restrictive interest for the property of the organization. On the opposite hand, courts have recognized that the veil of a corporation can be punctured to deny investors the protection that indebtedness commonly offers. “Piercing the company veil” alludes to the obligatory exception to the separate legal entity principle, whereby courts disregard the separateness of the corporation and hold the investors liable for the actions of the corporation as if it were the actions of the investors. A court might pierce the corporate veil where requested to do so by the company itself or investors to afford a remedy which may well be denied, manufacture associate in nursing an enforceable right, or scale back a penalty. It has been argued that the basic draw back with the decision in Salomon v A Salomon ; Co Ltd is not the principle of separate legal entity, but that the House of Lords gave no indication of: “What the courts should consider in applying the separate legal entity concept and the circumstances in which one should refuse to enforce contracts associated with the corporate structure.”
When courts pierce the company veil, they will take away the protection of limited liability otherwise granted to investors that may arise in issues for third parties. First, limited liability decreases the necessities for investors to look over the managers of firms during which they invest as a result of the financial consequences of company failure are restricted. Investors could have neither the motivation nor the expertise to look over the actions of managers. The potential operating expenses of the company is lessened as a result of limited liability. Second, limited liability provides perks for managers to act with efficiency and in the interests of investors by promoting the free transfer of shares. This argument has two elements thereto: The free transfer of shares is promoted by limited liability because beneath this principle the wealth of alternative investors is immaterial. If a principle of unlimited liability applied, the worth of shares would be determined partially by the wealth of investors. In alternative words, the worth at that a private investor would purchase a share would be determined partially by the wealth of that investor that was currently at risk due to unlimited liability. On the other hand, limited liability provides managers with incentives to act efficiently and within the interests of investors springs from the actual fact that if a company is being managed inefficiently, investors are expected to be merchandising their shares at a reduction to the worth which might exist if the corporate were being managed with efficiency. This creates the chance of a takeover of the corporate and also the replacement of the incumbent management. Third, limited liability assists the economical operation of the securities markets because as was determined within the preceding paragraph, the costs at that shares trade does not rely upon the analysis of the wealth of individual investors.
M Whincop, ‘Overcoming Corporate Law: Instrumentalism, Pragmatism and the Separate Legal
Entity Concept’ (1997) 15 Company and Securities Law Journal 411, 420.
These reasons are drawn from F Easterbrook and D Fischel, The Economic Structure of Corporate
Law, 1991, 41-44.