Court of chancery on corporate personality & civil procedure

Written by  //  August 20, 2010  //  Corporate Law and Business  //  2 Comments

Judicial indecision in the application of the doctrine of separate personality of corporations has created legal controversies in various branches of law. A recent order by the Court of Chancery (Delaware) in Dawson v. Pittco Capital Partners [Case No. 3148-CC] provides an interesting example. The plaintiffs in this case were seeking an order for production of documents by the defendant company. These documents included, inter alia, arbitration documents in the possession of a wholly-owned subsidiary of the defendant company. The subsidiary was not a party to the proceedings. Whether the plaintiff was entitled to such an order depended on the interpretation of Rule 34 of the Court of Chancery Rules which required production of such documents as were “within the possession, custody or control” of the defendant. The court held that, “Court of Chancery Rule 34 requires defendants to produce all documents within their possession, custody, or control. Here, documents of the wholly-owned subsidiary, Vehicle IP (VIP)—even though not a party to this action—are deemed controlled by its defendant parent, Vehicle Safety & Compliance, LLC (VSAC).

Though this ruling seems to go against the independent and separate legal personality of the defendant company and its subsidiary, the court in this case did not pause to consider whether the grounds for ‘lifting the veil’ were established. Instead, authority for this order was derived from the decision in E.I. DuPont de Nemours & Co. v. Phillips Petroleum Co. [621 F. Supp. 310]. This decision again, offers no reasoning for such a rule, but derives authority from two other decisions, one of the 5th Circuit in General Long-shore workers Union v. Smith [301 F.2d 791 (5th Cir.1962)] and the second, a Delaware District Court decision – Pennwalt Corp. v. Plough Inc. [85 F.R.D. 257 (D.Del.1979)]. A close reading of the former case indicates that the order in that case was based on the factual finding that the officers of the holding company exercised control over the subsidiary. In the second case, interestingly, the court refused such an order expressly upholding the separate personality of the companies concerned. The court in that case held, “there is no evidence in the instant case however, that Plough and Schering have identical Boards of Directors, or that their respective business operations are so intertwined as to render meaningless their separate corporate identities.” While establishing effective control exercised by the holding company over its subsidiary might have justified the order in Dawson, none of the above decisions seem to lay down the rule in Dawson as a blanket rule applicable to all fully-owned subsidiaries.

The District Court of Maryland in Diana Lollar Hubbard v. Rubbermaid [78 F.R.D. 631], though supported by little reasoning took an entirely different view. The court held in that case that such an order does not amount to “piercing the corporate veil” at all. Scholarly authority on the principles governing lifting the corporate veil however, seem to indicate otherwise. For instance, the seminal work by Prof. S. Ottolenghi [“From Peeping behind the Corporate Veil, to Ignoring It Completely”, 53(3) Modern Law Review 338 (1990)] characterises the modes of lifting the veil as four; ‘peeping behind the veil’, ‘piercing the veil’, ‘extending the veil’ and ‘ignoring the veil’. While ‘peeping behind the veil’ looks behind the corporate form only for obtaining new information which might be relevant in deciding the matter at issue, ‘piercing the veil’ imposes liability on shareholders for acts of the company. ‘Extending the veil’ questions the separate existence of the corporation, independently from a group of companies while ‘ignoring the veil’ questions the very existence of the company, for instance, as being a sham or façade. The author further suggests that declaring an agency relationship between the shareholder and the company on the basis of ‘control’ is a special mode of ‘penetrating the veil’. This recognises the direct interest of the shareholders in the controlled company’s acts.

Seen in this light, the order of the court in Dawson in my view amounts to ‘piercing the veil’. Rule 34 contemplates ignoring the separate legal personality of the corporations only once the element of ‘control’ is established. It is well-accepted that mere quantum of shareholding is insufficient to establish such control. [See, Kahn-Freund, “Some Reflections of Company Law Reform”, 7 Modern Law Review 54 (1944); Kahn-Freund, “Corporate Entity”, 3 Modern Law Review 226 (1940).] Hence, regardless of the fact that the subsidiary in Dawson was wholly-owned by the defendant company, application of Rule 34 requires an additional finding of fact that the court paid no attention to – that of establishing actual control exercised by the holding company.

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