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Separate Legal Personality

j IN THIS CHAPTER The Principle in Salomon v Salomon. . . . . . . . . The Implications of Separate Legal Personality . Piercing the Corporate Veil . . . . . . . . . . . . . . . Lifting the veil by statutory authority . . . . Agency. . . . . . . . . . . . . . . . . . . . . . . . . . Misuse of the corporate form . . . . . . . . . . Single economic entity . . . . . . . . . . . . . . .

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[303] [309] [316] [317] [319] [324] [328]

One of the key features of incorporation is that a company is deemed separate from its members (or owners), and therefore the company’s legal rights and obligations are wholly separate from its owners’ rights and obligations. Thus, creditors of the members have no claim against the company’s assets and creditors of the company have no claim against the members’ assets.

[301]

This chapter focuses on the concept of separate or corporate personality, its implications in practice and the circumstances where the veil of incorporation can be lifted or pierced.

[302]

j THE PRINCIPLE IN SALOMON V SALOMON The principle that a company is distinct and separate from its owners was emphatically endorsed in Salomon v Salomon.1 Mr. Salomon owned a boot manufacturing and leather business which was small but profitable. His sons worked in the business and pressed him to give them a stake. He was advised by his solicitor to incorporate a newly formed company, make his family directors and give them nominal shareholdings in the company, sell the business to the company and take the purchase price in fully paid up shares.

[303]

He duly did this and transferred the business for approx £39,000 to the company. The consideration for this was made up of:

[304]

1

[1897] AC 22.

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18 j Independent Colleges: Company Law

. 20,000 fully paid shares of £1 in the company. . A cash payment of approx £9,000. . A loan (debentures) from Mr Salomon to the Company of £10,000 secured by a floating charge. [305]

The company then fell upon hard times and went into liquidation. The net question was whether Mr Salomon’s secured debt of £10,000 should be paid by the company in priority to the debts amounting to circa £7,500 owing to the company’s unsecured creditors. The liquidator argued that the unsecured creditors should have priority, saying that the incorporation of the business by Mr Salomon was a mere scheme to enable him to carry on business in the name of the company with limited liability, contrary to the true intent and meaning of the Companies Act. It was argued that the scheme would enable him to obtain a preference over other creditors.

[306]

The Court of Appeal agreed wit the liquidator and said that the company was a sham and that Salomon was simply carrying on the same business as before through the agency of a company. In other words, there was no real independence between the company and its primary shareholder.

[307]

However, the House of Lords took a fundamentally different view and, in doing so, set down the foundations of modern company law. The House of Lords made clear that a company, once incorporated, was distinct from its members, and in order to incorporate one only need follow the requirements of the Companies Acts. Importantly, the House of Lords observed that that the Companies Acts did not permit an inquiry into the motives of the person in setting up the company. Furthermore, the Companies Acts did not stipulate that there should be a degree of independence between the shareholders and company. As the Irish judge, Lord MacNaghten, succinctly put it: ‘‘The company is at law a different person altogether from the subscribers to the memorandum and, though it may be that after incorporation the business is precisely the same as it was before, and the same persons are managers, and the same hands receive the profits, the company is not at law the agent of the subscribers or a trustee for them. Nor are the subscribers as members liable, in any shape or form except to the extent and manner provided in the Act.’’

[308]

The result of Salomon has been applied over a wide range of cases in England and Ireland. Generally, its implications mean that the courts will not go behind the separate personality of the company to get at members. However, the principle of Salomon has also (ironically) generated the exceptions to it. As Salomon prevents an enquiry into the motivations of persons setting up a company before a company is incorporated, this means that people can create companies for a wrongful purpose. Since then (and as we shall see), the courts have generated exceptions to this principle where the clear purpose of a company is to evade an obligation or to commit a fraud.

j THE IMPLICATIONS OF SEPARATE LEGAL PERSONALITY [309]

In practice, the fact that a company is deemed a separate entity from its owners can have certain implications, sometimes negative and sometimes positive, from the shareholders’ point

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of view. An example of a ‘‘positive’’ result can be seen in Lee v Lee’s Air Farming Ltd,2 where the plaintiff’s deceased husband held all but one of the defendant company’s shares and was its governing director for life. The articles also declared him a salaried employee. He was killed while carrying out work for the company and his widow claimed for social welfare compensation which was only available to ‘‘workmen’’. The authorities refused on the basis that he was not an employee. The Privy Council rejected this on the grounds that, following Salomon, one person could function in dual capacities and the fact that the deceased could control the company ‘‘did not alter the fact that the company and [he] were two separate and distinct persons’’. In other circumstances, the fact that a company is a separate entity may enable it avoid certain legal consequences. In Roundabout Limited v Beirne,3 a company, unwilling to deal with unionised staff, closed a pub which it operated and dismissed all its staff. The union, arguing that the closure was effected to force staff to leave the union, responded by picketing the premises. Meanwhile, the directors set up a new company (Roundabout Ltd) to which the business was transferred. This new company only hired barmen who were non-unionised, and hired them as directors. Since the new company had no employees, it could not be classed as an ‘‘employer’’ and thus could not be the subject of a trade dispute. Roundabout Ltd then sought an injunction restraining the picket, which was duly granted by Dixon J, who stated:

[310]

‘‘the new company is in law a distinct entity, as is the old company. Each company is what is known as a legal person. I have to regard the two companies as distinct in the same way as I would regard two distinct individuals. I must, therefore, proceed on the basis that a new and different person is now in occupation of the premises and carrying on business there.’’ However, the implications of the veil mean that there can be certain unfavourable consequences for shareholders. In Macaura v Northern Assurance Co,4 the plaintiff transferred his business to a company he controlled but inadvertently allowed the insurance policy on the company’s stock to remain in his own name. The stock was subsequently destroyed in a fire. It was held that he could not claim on the insurance policy because he did not possess the requisite insurable interest in that stock. The stock belonged to his company and not to him.

[311]

Similarly, in Turnstall v Steigman,5 a landlord of property sought to resist granting a new tenancy on the ground that she required the property for the purposes of a business carried on in a neighbouring premises. In fact this business was being carried out by a company in which the landlord was a majority shareholder, thus it was not a business which she was carrying out. It was thus held that she could rely on another entity’s business requirements to defeat the tenant’s claim.

[312]

As the company is deemed a separate entity, it means that if the company suffers a loss, the only person who can sue for that loss is the company itself. Furthermore, if a shareholder loses value in his shares as an indirect consequence, he will have no right of action as against the principal wrongdoer. This was well illustrated in O’Neill v Ryan & ors,6 where the plaintiff

[313]

2 3 4 5 6

[1961] AC 12 (1959) IR 243. [1925] AC 619. [1962] 2 QB 593. (1993) ILRM 557.

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20 j Independent Colleges: Company Law alleged that breaches in competition law by the four defendants had caused a diminution in the value of his shares in the second-named defendants, Ryanair Limited. The Supreme Court held that actions by four of the defendant companies did not entitle a shareholder to sue on the basis that the actions of the companies had reduced the value of his shares because such a loss is merely a reflection of the loss suffered by the company. In coming to his conclusion, Blayney J quoted from a decision of the English Court of Appeal in Prudential Assurance Company Ltd v Newman Industries Ltd (No 2),7 where the very nature of a share meant that a shareholder could not sue for loss which the company suffered: ‘‘the plaintiff’s shares are merely a right of participation in the company on the terms of the articles of association. The shares themselves, his [P] right of participation, are not directly affected by the wrongdoing. The Plaintiff still holds all the shares as his own absolutely unencumbered property.’’ [314]

A similar argument was raised in Stein v Blake,8 where the plaintiff and defendant were 50/50 shareholders in a group of companies. The plaintiff claimed that the defendant, in breach of his fiduciary duties, had caused assets of the company to be sold at an undervalue. The plaintiff claimed that this action had deprived him of the ability to sell his shares at their fair value and this had caused him personal loss. Millet LJ observed the that plaintiff was claiming that he had suffered a loss by reason of a misappropriation of the company’s assets. The plaintiff’s loss was merely a reflection of the company’s loss and would be fully compensated by restitution to the company of the misappropriated assets.

[315]

In Giles v Rhind,9 it was recently held that: ‘‘a loss claimed by a shareholder which is merely reflective of a loss suffered by the company  i.e. a loss which would be made good if the company had enforced in full its rights against the defendant wrongdoer  is not recoverable by the shareholder . . .’’

j PIERCING THE CORPORATE VEIL [316]

As always, there are exceptions to the general principle that the owners of a company will be treated as distinct from the company itself. It is manifest throughout these exceptions that the common thread for lifting the veil is to avoid a demonstrable injustice from occurring. There are many circumstances where the veil can be lifted. However, the more important areas for our purposes are where the veil is lifted by . . . .

Statutory authority; Agency; Misuse of the corporate form; or Single economic entity.

Lifting the veil by statutory authority [317]

There are numerous statutes under which controllers or dominant shareholders are expressly made personally liable or accountable for certain activities. For example, under s 297A of the 1963 Act (as inserted by the 1990 Act), an officer of the company such as a director can be

7 8 9

(1982) Ch 204. [1998] 1 All ER 724. [2003] Ch 618.

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declared (by a liquidator or examiner) to be personally liable, without limitation, for all or part of the debts of the company for reckless or fraudulent trading. Pursuant to s 140 of the 1990 Act, closely related companies may be required in certain cases to contribute towards payment of each others’ debts when one of them is being wound up, and under s 141 of the 1990 Act, the court may direct that the same companies’ assets be pooled. Other types of legislation may provide for the piercing of the veil. The Tax Acts contain numerous instances where companies and their owners are treated as one and the same, for example where there are transactions with ‘‘participators’’ in ‘‘close companies’’. Equally, health and safety legislation can be directed at both companies and their officers. In DPP v Roseberry Construction Ltd,10 a company and its director were both fined for breaches of health and safety legislation, which had led to a fatality. The director appealed the severity of the fine and argued that he himself should not be personally fined as the company and him were separate persons. The Court of Criminal Appeal held the principle of separate legal personality can be pierced by legislation and can impose individual liability on both the company and its director.

[318]

Agency There are a series of cases where the courts have been prepared to infer the existence of agency between a company and its owner/shareholders, particularly where the owner/shareholder is itself another company. In Smith Stone & Knight v Birmingham Corporation,11 a holding company was the owner of property in which one of its subsidiaries was carrying on business. When this property was compulsorily acquired by the local corporation, the holding company was held entitled to compensation for disturbance to the business which arose from the need to relocate. Atkinson J took the view that the subsidiary was carrying on business as the agent of the holding company. He listed the following factors, all based on the control over day-today operations, to be taken into account: (1) (2) (3) (4) (5) (6)

[319]

Are the profits of the subsidiary treated as the profits of the parent? Were the persons conducting the business of the subsidiary appointed by the parent? Was the parent the ‘‘head and brains’’ of the trading venture? Did the parent govern the adventure? Were the subsidiary company’s profits made by the skill and direction of the parent? Was the parent in effective and constant control of the subsidiary?

This reasoning has been criticised by Keane, who points out that these criteria may not be capable of general application. He says that if an agency were to be inferred in every such case, a significant number of subsidiaries would be treated as the agents of their holding companies. If this were so it would potentially expose those holding companies directly liable for the debts and liabilities of its subsidiary, which would open a huge breach into the principle of limited liability.12

[320]

Notwithstanding the foregoing, the High Court has recently reaffirmed the existence of the agency principle in Fyffes v DCC.13 In this case, DCC plc had bought shares in Fyffes which it

[321]

10 11 12 13

Unreported, Court of Criminal Appeal, 6 February, 2003. [1939] 4 All ER 116. Keane, Company Law (4th ed, Thomson Round Hall), para 11.36. Unreported, High Court, Laffoy J, 21 December, 2005.

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22 j Independent Colleges: Company Law had passed on to its subsidiary, Lotus Green. DCC’s chief executive officer, Mr Flavin, also sat on the board of Fyffes. Lotus Green sold the shares in February 2000 at an unprecedented high price. It was alleged that when these were sold, James Flavin was in possession of inside information in relation to Fyffes. Under the relevant legislation (Pt V of the 1990 Act) a company could not sell shares if one of its directors was in possession of price-sensitive information in respect of those shares. Whilst Mr Flavin was a director of DCC, he was not an official director of Lotus Green. One of the issues which arose was whether Lotus Green owned and sold the shares as agent of DCC. If it did, then in law it would be as if DCC had sold the shares itself. If DCC owned and sold the shares itself, it would be liable because Mr Flavin was a director of DCC. [322]

Laffoy J reviewed the law whereby a company might be deemed the agent of another and distilled the following principles. First, as a matter of law Lotus Green may be regarded as having acted as the agent of DCC in relation to the holding and disposal of the shares in Fyffes, if to do otherwise would lead to an injustice. However she adopted the proviso that a subsidiary would, however, only be deemed an agent of its parent where such an inference was factually justified. She rejected the argument that only evidence of an express agency agreement between the parties will suffice. Rather, agency will be determined by reference to all the facts, including the nature of the parent’s interest in the shares of the subsidiary and the relationship between both. She said the views of the human agents in the company was not in any way determinative of the situation.

[323]

On the facts of this case she did not find that Lotus was an agent of DCC as regards the holding and disposal of the shares and in the acquiring of the profit from their sale. Whilst Lotus held the shares, it held them independently from DCC. It did not hold them as agent for DCC.

Misuse of the corporate form [324]

One clear exception to the principle of separate legal personality is where the statutory privilege is being used for a fraudulent purpose. An example of this can be seen in Re Bugle Press,14 where the holders of 90 per cent of the shares in a company wished to buy out the remaining 10 per cent owner, who was refusing to sell. In order to achieve their objective, the 90 per cent holders formed a new company, transferred their 90 per cent share to that company and then attempted to compulsorily acquire the remaining 10 per cent under the statutory procedure for buying out a minority shareholding when a company is the subject of a takeover.15 The minority shareholder sought relief from the courts, arguing that this was not a genuine takeover bid and, thus, the compulsory acquisition provisions could not apply. The Court of Appeal agreed, saying the arrangement was effectively a sham.

[325]

Another strand of this exception is the view that one cannot use the corporate veil with a view to evading a legal obligation. In Gilford Motor Company v Horne,16 the defendant had entered into an agreement with Gilford not to canvass their customers after he left the company’s employment. He sought to get around this obligation by forming a company and using it to carry out the canvassing. It was held that he and his company could be stopped from such

14 15 16

[1961] Ch 270. s 204, 1963 Act. [1933] Ch 935.

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activities. Similarly, in Jones v Lipman,17 the defendant who had contracted to sell his house to the plaintiff tried to avoid a claim for specific performance to sell the house. He conveyed the house to a company which he owned and controlled in an effort to evade the Plaintiff’s enforceable contract for sale. Russell J rejected a defence based on the company being a separate entity, describing the company as: ‘‘the creature of the defendant, a device and a sham, a mask which he holds before his face in attempt to avoid recognition by the eye of equity’’. However, it must be remembered that there can be a fine distinction between a legitimate and illegitimate use of the corporate form. The formation of a company which has no genuinely separate existence is not of itself unlawful. We already saw in Roundabout v Beirne that the corporate veil can be used to avoid certain legal consequences (as opposed to evading legal obligations).

[326]

Similarly, it was held in Adams v Cape Industries18 that the attempt to avoid potential future liabilities or consequences is not unlawful or fraudulent. Here the defendant company was a parent of a number of subsidiaries in the USA. These subsidiaries specialised in the manufacture of asbestos. A large number of the employees in these subsidiaries brought actions claiming their health had been damaged due to exposure to asbestos dust, and it was sought to enforce judgment in the proceedings against the defendant parent company in the UK. The Court of Appeal found that one of the reasons for setting up the corporate structure in this way was to reduce the risk of the defendant being subject to the jurisdiction of the US courts. However, this was entirely legitimate. Slade LJ said arrangement of the corporate structure so as to ensure that legal liability (if any) in respect of particular future activities of the group will fall on another member of the group rather than the defendant company was a right inherent in our corporate law.

[327]

Single economic entity The establishment of the concept There are a number of cases which demonstrate the courts may hold a collection or group of companies to be, for the purpose of a particular legal aim, a single entity. These cases generally centre on the principal that the companies in question are closely related, act in tandem and that justice of the case so requires them to be treated as one. The starting point for this analysis stems from the seminal case of DHN Food Distributors Limited v Tower Hamlet LBC.19 DHN had two wholly owned subsidiaries, one which owned the property of the group and one which ran the business of the group, occupying the property as a licensee. Here the defendant local authority made a compulsory acquisition of property of the land-owning subsidiary. The parent company then sought compensation for disturbance. However, the land tribunal only offered negligible compensation since the business-owning subsidiary had been deprived merely of a revocable license and the propertyowning subsidiary had no business to lose. Denning LJ stated that courts had a general tendency to look at the economic identity of the whole group and that this particularly applied when the holding company held all the shares in the subsidiary (a wholly owned

17 18 19

[1962] 1 ALL ER 442. (1990) BCLC 479. [1976] 3 All ER 462.

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[328]

[329]


24 j Independent Colleges: Company Law subsidiary) and can control it. He went on to hold that the parent should not be deprived of compensation due to a technical point when it was justly payable, and so the companies in question would be treated as one company. [330]

This case was adopted by Costello J in Power Supermarkets Limited v Crumlin Investments Limited et al.20 The defendant owned Crumlin shopping centre. It entered into an agreement with the plaintiff, which controlled Quinnsworth, to grant a lease and agreed not to grant a similar lease to anyone else of a similar unit for the purpose of selling groceries. The shares in the defendant were then sold to a company called Cornelscourt Shopping Centre Limited, which was one of the Dunnes Stores group of companies. Dunnes Stores wished to have its own retail outlet in the shopping centre and set up a company called Dunnes (Crumlin) Ltd to acquire one of the units from the defendant. This unit was conveyed to Dunnes (Crumlin) Ltd for a nominal consideration. The question was whether Dunnes (Crumlin) Ltd was bound by the original covenant to the plaintiff.

[331]

Costello J found that Dunnes (Crumlin) Ltd to be so bound and said that he could treat two or more related companies as being a single entity if this conforms to the economic realities of the situation and if the justice of the case so required.

[332]

The move away from Single Economic Entity In England there has been a noticeably shift way from the DHN approach. More recent authorities suggest that the justice of the case will only permit a company to be regarded as part of a single economic entity where it is established merely as a ‘‘fac¸ade’’ to conceal improprieties. For example, in Woolfson v Stathclyde Regional Council,21 Lord Keith of Kinkel said: ‘‘I have some doubts . . . whether the Court of Appeal properly applied the principle that it is appropriate to pierce the coporate veil on ly where special circumstances exist indicating that it is a mere fac¸ade concealing the true facts.’’ Furthermore, in Adams v Cape Industries public limited company, Slade LJ stated that: ‘‘the court is not free to disregard the principles of Salomon v Salomon merely because it considers that justice so requires. Our law, for better or worse, recognises the creation of subsidiary companies which though in one sense are the creatures of their parent companies, will nevertheless . . . fall to be treated as separate legal entities with all the rights and liabilities which would normally attach to separate legal entities.’’

[333]

A similar trend can be gleaned in Ireland. In State (McInerney & Co Ltd) v Dublin County Council,22 a subsidiary served a purchase notice on a local authority under planning legislation in respect of land which its holding company owned. The local authority disputed the validity of the notice as the subsidiary did not own the lands. In challenging this decision the subsidiary relied on the DHN case, arguing the companies should be treated as one. Carroll J rejected this, responding that the business group operated its corporate structure so as to maximise the benefits to be gained from the distinct legal personal of each subsidiary. Thus, because the corporate group was using and claiming the benefit of separate legal

20 21 22

Unreported, High Court, 22 June, 1981. (1978) SC 90. [1985] ILRM 513.

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personality, it would not be allowed to lift that veil at the same time just because it now suited them. She stated: ‘‘the corporate veil is not a device to be raised or lowered at the option of the parent company or group. The arm which lifts the corporate veil must always be that of justice.’’ In Rex Pet Foods Limited v Lamb Bros (Dublin) Limited et al,23 the receiver of Rex tried to argue that business and assets of both it and its parent company, Lamb Bros, should be treated as one on the basis that they were closely related. Costello J refused to disregard the separate legal personalities of a group of companies under common ownership and control. It was held that the fact that the defendant occasionally discharged Rex’s creditors was not a sufficient basis to declare a single legal entity. Neither was the fact that one company accepted invoices on behalf of another, nor the change in management, nor the conduct of board meetings. Even the fact that the defendant was sole distributor of Rex’s products was deemed insufficient.

[334]

The limitations to the single economic entity concept were clearly marked out in Allied Irish Coal Supplies Ltd v Powell Duffryn International Fuels.24 The plaintiff alleged that the defendant was in breach of a commercial contract concerning the supply of industrial coal. The defendant was a wholly-owned subsidiary of Powell Duffryn plc. The plaintiff then became aware that the defendant’s parent company was selling the defendant. The plaintiff applied to join the parent company as a co-defendant. It appears that the plaintiff was concerned that the defendant would have insufficient funds to pay the debt. In the High Court, Laffoy J refused the application, saying the concept of single economic entity

[335]

‘‘cannot be used to render the assets of a parent company available to meet the liabilities of a trading subsidiary, to a party with whom it has traded. The proposition advanced by the plaintiff seems to me to be so fundamentally at variance with the principle of separate corporate legal personality laid down in Salomon v Salomon & Co,, and the concept of limited liability, that it is wholly unstateable . . .’’ In the Supreme Court, Murphy J agreed and stated: ‘‘The corner stone of company law was put in place just one hundred years ago by the decision of Solomon. Not merely did that case decide that a company incorporated under the Companies Acts is a legal entity separate from its promoters and members, but it was recognized that this was so, even though the company was incorporated for that purpose and with the result that the distinction operated to the manifest detriment of those dealing with the company in the ordinary course of business.’’ Murphy J also pointed out that if he was to accede to the plaintiff’s request, it could work an injustice on the creditors of the parent company as it could mean that assets which should be used to pay them would be used to pay creditors of its subsidiary. He concluded by saying that:

23 24

Unreported, High Court, 5 December, 1985. [1998] 2 IR 519.

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[336]


26 j Independent Colleges: Company Law

‘‘whilst it would be impossible to say that there are no circumstances in which the members of a company . . . could not conduct, or purport to conduct, the business of a company in such a way as to render their assets liable to meet claims in respect of the business nominally carried on by the company, I believe that this would be an exceptional state of affairs.’’ [337]

Recent Re-Affirmation of Single Economic Entity in Fyffes v DCC The facts of Fyffes v DCC have already been outlined above. It may be recalled that one of the defences made out by DCC was that Lotus Green was not in possession of the price-sensitive information because Mr Flavin was not its director. One of the other arguments made by the plaintiffs was that DCC and Lotus Green could be a single economic entity. In this way, although Mr Flavin was not a director of Lotus Green, he could be deemed a director of the ‘‘group’’. Laffoy J set out the relevant principles that could be applied in relation to single economic entity. She stated that both companies could only be treated as a single economic entity where the plaintiff has established: (a) an evidential basis exists for finding that, as regards the holding and disposal of the shares, to borrow the terminology used by Murphy J. in the Lac Minerals Limited case, there was a factual identification of the acts of Lotus Green and DCC and (b) not to so treat the companies would allow the DCC Group to evade its obligations under Part V. In relation to the point at (a), Laffoy J found that in fact there was this factual identification because (i) The shares were an asset of the DCC group and treated as such in consolidated balance sheet. (ii) Mr. Flavin made the agreements to sell the shares as agent for DCC group. The three companies in question implemented that agreement . . . (iii)Profit from the sale came about from the implementation of the agreement. In relation to point (b) above, it was clear that the purpose of incorporating Lotus Green was not to avoid liability for insider trading but to mitigate tax liability. However, despite this Laffoy J held that by defending the claim on the basis that Lotus Green was a separate entity from DCC, the DCC Group was effectively trying to evade liability for insider trading. In summary, she concluded that not to treat them as one would result in DCC evading its obligations under the insider trading laws under Pt V of the Companies Act.

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