VTB Capital: The Consequences of Lifting the Corporate Veil


The
Court of Appeal earlier this year gave judgment on an important issue of
corporate law: the consequence of
lifting the corporate veil, and, in particular, whether the puppet is deemed to
have become a party to contracts entered into in the puppeteer’s name (VTB Capital v
Nutritek
). The issue is of practical importance because an affirmative
answer to this question would allow claims to be framed in contract which would
otherwise be framed differently, and of conceptual importance because it reveals the nature of the remedy (ie, what courts
mean when they “lift” the corporate veil). As we discuss below, the Bombay High
Court and the Court of Appeal have given opposite answers to this question, and
the UK Supreme Court is scheduled to hear the appeal against VTB Capital on 12 November.

VTB Capital
was a dispute that arose out of a loan that was obtained fraudulently. VTB, a
company incorporated in England and a subsidiary of a Russian company, was
induced to give a loan of about $220 million to Russagroprom LLP [“RAP”] to fund the acquisition of
certain dairy companies [“the Dairy
Companies
”] from Nutritek, a company incorporated in the British Virgin
Islands [“Nutritek”]. The loan was
made under a Facility Agreement to which the parties were VTB, Nutritek, RAP
and RAP’s parent companies as guarantors. The parties to the Share Purchase
Agreement (through which RAP bought the Dairy Companies) were RAP, Nutritek and
Newblade (the company whose shares were transferred to RAP). The Facility
Agreement stipulated that VTB would release funds only after receiving an
independent valuation report.

Soon
after the loan was made, RAP defaulted, and VTB was left with a considerable
shortfall after realising its securities. VTB realised that it had been induced
into entering into the Facility Agreement by two fraudulent misrepresentations:
(i) that Nutritek and RAP were not
under the ultimate control of the same person and (ii) a substantial and deliberate exaggeration of the value of the
Dairy Companies, leading to a misleading valuation report. VTB initially
brought a claim in contract against VTB, and in tort against Marcap BVI, Marcap
Moscow and Mr Malofeev. The allegation was that Marcap BVI, which owned Marcap
Moscow, had a substantial stake in Nutritek, and that Mr Malofeev was the controller
of all three companies (this was the basis of (i) above). VTB then applied for leave to amend its Particulars of
Claim to allege liability in contract against
Marcap BVI, Marcap Moscow and Mr Malofeev, on the basis that, once RAP’s veil
was pierced, those who controlled it became parties to the Facility Agreement.
It is of interest to note that VTB ran this case purely for jurisdictional reasons: a claim in contract would have strengthened
its attempt to establish the jurisdiction of the English courts with respect to
sue Marcap BVI, Marcap Moscow and Mr Malofeev.

In
VTB Capital, Mr Snowden QC argued that the legal
consequence
of lifting the corporate veil is that the controller is
regarded as an additional party to contracts entered into in the name of the
company he controls. This, it was argued, was not a matter of “discretion” or a
“remedy” devised by the court to do justice, but simply the logical consequence
of ignoring the fact that the puppet is a separate legal entity. The
outstanding submissions of counsel and the Court’s equally outstanding analysis
repay careful study, for these trace the development of the corporate veil as a
remedy from the time it was devised to the way in which it is used today, and
consider analogies, if any, with the law of undisclosed principals. What
follows here is no more than a brief summary of this analysis. Burton, J, in
two decisions (Antonio Gramsci
and Alliance Bank),
had accepted this argument, but Arnold, J, in the judgment under appeal, held
that those cases were wrongly decided. Mr Snowden relied on the Court of Appeal’s
well-known judgment in Gilford Motor Co v
Horne
[1933] Ch. 935.
In that case, the claimant obtained an injunction restraining Mr Horne and JM
Horne & Co from carrying on competing business. Mr Horne had entered into a
contract which restrained him from doing this, but JM Horne & Co had not. Mr
Snowden’s case in VTB was that no
injunction could have been granted against JM Horne & Co except in support
of an independent cause of action
against it; that cause of action could have only been that JM Horne & Co
was deemed, once the corporate veil
was lifted, to have become a party to Mr Horne’s contracts. Lloyd LJ rejects
this reading of Gilford, and holds
that the Court of Appeal granted an injunction against the company only because
it was “practically convenient” to do so; an injunction against Mr Horne alone
would have sufficed, since there was a finding that he was in breach of the
covenant through the company, but it was
convenient to grant this remedy against the company as well. Jones v Lipman, Trustor and other cases were similarly explained.

It
was also suggested that there is an analogy with the law of undisclosed
principals, which allows a third party to sue the undisclosed principal even
though he did not know of his existence when he entered into the contract; it
was said that a case where a controller deceives a contracting party into
thinking that the puppet is not a puppet is identical because it is also a case
where the controller acts through another without the knowledge of the other
party to the contract. Lloyd LJ rejected this submission because the third
party is allowed to sue an undisclosed principal only if the agent entered into
the contract within the scope of his actual
authority, and, in a corporate veil case, the controller by definition does
not authorise the puppet to enter into a contract on his behalf.

In
the course of its careful review of the authorities, the Court of Appeal also
made two other important points: first,
“lifting the corporate veil” does not ignore the existence of the company, but
allows the court to provide a remedy that would otherwise be available only
against the company (as opposed to the controller, or vice versa); secondly, there is no requirement that
the corporate veil can be lifted only if it is necessary to do so (ie,
that there is no other remedy) and Dadourian and
Hashem v Shayif,
to the extent they suggested there is, are incorrect.

The
Bombay High Court, in a case we have discussed
on this blog, cited Burton J’s judgment in Gramsci
for the proposition that a contract may be enforced against the puppet as
well as the puppeteer. Unfortunately, the Court did not consider this issue in
detail, or the arguments against Burton J.’s interpretation of Gilford Motor Co. This case is now
before the Supreme Court.

There
is no doubt that this is a difficult issue as to which there is more than one
reasonable view. The strongest argument in favour of the appellants in VTB Capital appears to be the reasoning
in Gilford Motor Co v Horne. The
strongest argument to the contrary is that (as the Court of Appeal points out)
it is difficult to reconcile this proposition with the principle that a
contract, construed objectively, creates rights and obligations only between
parties (subject to certain exceptions that are irrelevant here). Another difficulty
with the argument is that the controller will be deemed to have become a party
to the puppet’s contracts even if the fraud he perpetrated was not that the
puppet was not controlled by him. In VTB,
this issue did not arise because the allegation (assumed to be true) was that
Mr Malofeev had fraudulently represented that Nutritek and RAP were controlled
by different entities.

The
Supreme Court’s decision in VTB Capital is
keenly awaited.

About the author

V. Niranjan

1 comment

  • Following are the observations, in the order of general significance or interest:
    1.In the judgment, in a particular context, there is a concept of -"substantial question of fact or law or both" referred to. It seems to be strikingly distinct from the commonly known concepts (as often gone into in decided Indian tax cases) of – "question of law","mixed question of law and facts"; and now, under the modified code-"substantial question of law".
    Further, so far as could be seen (subject to correction),the court does not seem to have dealt with or given any specific finding on this aspect.
    2. The judgment being one of an English court makes for somewhat a laborious/time consuming reading; typical of its kind, in that, because of the given natural gift of language, the judiciary has never had any difficulty in handing out such long winding judgments, though to the delight of the domestic lawyers, if not to their brethren abroad, or to the litigants as a class.

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