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One of the fundamental principles of company law is that a company has personality that is distinct from that of its shareholders. This rule was laid down by the House of Lords in Salomon v. Salomon & Co  A.C. 22, in which it was held that even if one individual held almost all the shares and debentures in a company, and if the remaining shares were held on trust for him, the company is not to be regarded as a mere shadow of that individual. Lord MacNaughten statedm Ibid, at p. 51: “The company is at law a different person altogether from the subscribers to the Memorandum and, although 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 in law the agent of the subscribers or the trustee for them. Nor are subscribers as members liable, in any shape or form, except to the extent and in the manner provided by the Companies Act 1862.” The rule in Salomon lies at the heart of corporate personality, and is the principal difference between companies and partnerships. However, there are situations in which the courts look beyond that personality to the members or directors of the company: in doing so they are said to lift or pierce the corporate veil. There is no single basis on which the veil may be lifted, rather the cases fall into several loose categories, which are examined below. STATUTORY EXCEPTIONS 3. There are certain statutory exceptions to the rule in Salomon which involve a director being made liable for debts of the company because of breach of the companies or insolvency legislation. E.g.:
(a) Failure to obtain a trading certificate 4. Where a public company fails to obtain a trading certificate in addition to its certificate of incorporation before trading, the directors will be liable to the other parties in any transactions entered into by the company to indemnify them against any loss or damage suffered as a result of the company’s failure to comply with its obligations. This provision Companies Act 1985, s.117 (8) has been retained in the 2006 Act. See CA2006 s767 i.e. Companies Act 1862 b) Failure to use Company’s name 5. Section 349(4) of the CA 1985 provided that if an officer of a company or a person acting on its behalf signs a bill of exchange, cheque or similar instrument on behalf of the company, in which the company’s name is not mentioned4, that person will be personally liable to the holder of the instrument in question for the amount of it (unless it is duly i.e.
Companies Act 1862 4 Thus contravening s.349 (1)(c) of CA 1985 paid by the company). However, although CA2006 s.84 imposes criminal penalties for failure to use the company name on relevant documents, there is currently no equivalent provision in the 2006 Act imposing such a personal liability. (c) Disqualified Directors 6. Under s.15 of the Company Directors Disqualification Act 1986, if a person who has been disqualified from being a director of, or involved in the management of a company acts in contravention of his disqualification he will be liable for all those debts of the company which were incurred when he was so acting. The same applies to a person who knowingly acts on the instructions of a disqualified person or an undischarged bankrupt. Just and Equitable Winding Up 7. Under s.122 (1)(g) of the Insolvency Act 1986 a petition may be presented to wind up a company on the grounds that it would be just and equitable to do so. This may involve lifting the veil of incorporation, for example to examine the basis on which the company was formed E.g. Ebrahimi v. Westbourne Galleries  AC 360 (e) Fraudulent Trading 8. Section 213 of the Insolvency Act 1986 deals with fraudulent trading. Under that section, if it appears to the court that “any business of the company has been carried on with intent to defraud creditors of the company or of any other person, or for any fraudulent purpose”, it may order that “any persons who were knowingly parties to the carrying on of the business in the manner above-mentioned are to be liable to make contributions (if any) to the company’s assets as the court thinks proper Wrongful Trading 9. Section 214 of the Insolvency Act 1986 concerns wrongful trading, and enables the court to make a declaration, when a company has become gone into insolvent liquidation, that a former director is liable to make a contribution to the company’s assets. Such a declaration can be made where the director in question knew or ought to have concluded, at some point before the commencement of the company’s liquidation, that there was no reasonable prospect that the company would avoid going into insolvent litigation. By s.214 (7), the provisions of s.214 also apply to shadow directors. (g) Phoenix Companies 10. The Insolvency Act 1986 also allows the court to lift the corporate veil in cases of so called “Phoenix Companies”, in which a new company is created with the same or a similar name to an insolvent company. S. 216 of the Act makes it an offence for anyone who was a director of the insolvent company during the 12 months before liquidation to be
associated with a company with the same name as the insolvent company or a name so similar as to suggest an association6. S.217 provides that where a person is involved in the management of a company in contravention of s.216, or where he acts, or is willing to act, on instructions given by a person whom he knows to be in contravention of that section, he is himself jointly and severally liable with the company for all the relevant debts of that company. (h) Unfair Prejudice 11. The Courts’ powers under s.459 of the 1985 Act (the provisions of which are duplicated in s.994 of the 2006 Act) apply where “the company’s affairs are being or have been conducted in a manner which is unfairly prejudicial to the interests of its members generally or of some part of its members (including at least himself)." The general proposition that the conduct of a parent company in control of a subsidiary can be relevant where a s.459 petition is presented by shareholders of a subsidiary is unsurprising7. It has also been held by the Court of Appeal: Citybranch Ltd v Rackind  EWCA Civ. 815 that directors’ unfairly prejudicial conduct of a subsidiary may be actionable by shareholders of the parent under s.459 if the parent and subsidiary have directors in common. (i) Third Party Costs Orders 12. The court has jurisdiction to make a costs order against a party to the proceedings in favour of a non-party (including the directors or shareholders of a litigant company) by virtue of s.51 Supreme Court Act 1981 and CPR 48.2. This has recently been applied by the Court of Appeal in the case of Alan Phillips Associates Ltd v Terence Edward Dowling  EWCA Civ 64 . A contract was accepted by a company on headed paper almost identical to that of a business run by Mr Phillips prior to incorporation. Mr Phillips wrongly issued proceedings in his own name and the company was then substituted as Claimant. The company’s claim was dismissed and a third party costs order was made against Mr Phillips. 13. More typical circumstances for a third party costs order arose in Goodwood Recoveries Ltd v Breen10 which held that where a non-party director could be described as the "real party" seeking his own benefit and controlling and/or funding the litigation, then even where he had acted in good faith or without any impropriety justice might demand that he be liable in costs.
14. Similarly in CIBC Mellon Trust Co v Stolzenberg11 when the court held that there was no reason in principle why, if a shareholder (not being a director or other person duly authorised, appointed and legally obliged to act in the best interests of the company) funded, controlled and directed litigation by the company in order to promote or protect his own financial interest, the court should not make a costs order against him.
Law of Associations 200018 Semester 2, 2002
Copyright © 2002 Thomas Feerick Lecturer School of Law, UWS
Lecture 5 – Week 5
This lecture has two parts. Part 1 discusses the concept of incorporation and its main consequences. These consequences flow from the basic point that in law a company is separate from its members and management. Part 2 considers the circumstances in which the so-called ‘corporate veil’ may be lifted or pierced. In this context it is shown that a court may decide (or be obliged) to ignore the fact of incorporation and treat a particular matter or transaction as if there was no company interposed. 2. THE CONSEQUENCES OF INCORPORATION
The main consequence of incorporation is the incorporated ‘thing’ (eg. company) becomes a distinct legal entity: it is a ‘legal person’ (ie, capable of holding legal rights and having legal obligations) which exists separately from its members and controller(s). The above principle was illustrated in R v Arnaud (1846) 9 QB 806, where a registering authority refused to register a ship on the ground that some of the ship’s owners were foreigners. The ship was owned by a (British) chartered company whose members happened to include foreigners. The court ordered the registering authority to register the ship on the basis that the (British) company was the ship’s owner rather than the members of the company. The unanimous decision of the House of Lords in Salomon v Salomon & Co Ltd  AC 22 (the facts are recited below) is often cited as the authority which settled the point that a company has a distinct legal personality. In Salomon’s case, Lord Halsbury LC said: the learned judges [below] appear to me not to have been absolutely certain in their own minds whether to treat the company as a real thing or not. If it was a
real thing; if it had a legal existence, and if consequently the law attributed to it certain rights and liabilities in its constitution as a company, it appears to me to follow as a consequence that it is impossible to deny the validity of the contract into which it has entered. However, it should be noted that the House of Lords in Salomon’s case really only decided that Salomon & Co Ltd was a company duly incorporated under the Companies Act 1862 (UK) even though its seven shareholders were not truly ‘independent’: all of the statutory requirements were satisfied because the company had seven shareholders. At least four points follow from the proposition that incorporated companies have a separate legal personality: • • Company’s property is company’s property; Company’s debt is company’s debt; Companies can contract with their members, directors and outsiders (and visa versa); and Companies can commit torts and crimes.
While some writers have categorised these points as being either advantageous or disadvantageous, this obviously will depend on the standpoint from which the value judgment is made. Is it from the standpoint of the company, its shareholders or an unpaid creditor? (a) The Company’s Property
R v Arnaud (1846) 9 QB 806 demonstrates the basic point that the controllers of a company (ie., its directors or shareholders) do not own the company’s property – the company does. In Macaura v Northern Assurance Co Ltd  AC 619, five insurers refused to pay the appellant’s insurance claim on the ground that he did not have an insurable interest. The appellant Mr Macaura had sold all of the timber then standing upon his land to a company, in which he was a shareholder and creditor, for £42,000. After the assignment, Macaura had insured the timber against fire damage by policies in his own name. The House of Lords upheld the insurers’ refusal to pay. Lord Buckmaster’s decision represents the Court’s view: The appellant could only insure either as a creditor or as a shareholder in the company, and if he was not entitled in virtue of either of these rights he can acquire no better position by reason of the fact that he held both characters. As a creditor his position appears to me quite incapable of supporting the claim …
Turning now to his position as a shareholder, this must be independent of the extent of his share interest. If he were entitled to insure because he held all the shares in the company, each shareholder would equally be entitled if the shares were indifferent hands. Now, no shareholder has any right to any item of property owned by the company, for he has no legal or equitable interest therein. … If he were at liberty to effect an insurance against loss by fire of any item of the company’s property, the extent of his insurable interest could only be measured by determining the extent to which his share in the ultimate distribution [upon winding up] would be diminished by the loss of the assets – a calculation almost impossible to make. Lord Wrenbury shortly observed that: This appeal may be disposed of by saying that the corporator, even if he holds all the shares, is not the corporation, and that neither he or any creditor of the company has any property, legal or equitable, in the assets of the corporation. This case would not be decided the same way today under the Insurance Contracts Act 1984 which dispenses with the common law rule requiring the insured to hold an insurable interest before being entitled to benefit under the insurance policy. (s 16) The Corporations Act reflects the common law principle that companies can own property. For example, s 119 provides that upon registration a company becomes a body corporate; s 124(1) states that a company has the capacity of a natural person. It follows, therefore, that a registered company can acquire the same kinds of proprietary rights that a natural person may acquire. (b) The Company’s Debts Just as a natural person can incur debts, so may companies. However, it must be recalled that a company is a legal abstraction the existence of which is evidenced by a certificate rather than any physical presence. It follows, therefore, that a company cannot act except through a natural person (ie., a conduit), but in such a case the company is the ‘actor’. Thus, persons (legal or natural) may act in various capacities: 1. 2. 3. 4. In their own right and on their own behalf (ie, as principal); In their own right but as trustee for a company; On behalf of a company (ie, as agent); As the company (ie, alter ego).
In Salomon’s case, Vaughan Williams J and the Court of Appeal failed to accept the (4th) proposition that a company may carry on a business and incur debts in its own right, and it
does not necessarily act as an agent or trustee for a natural person just because that person happens to control the company (eg, own the majority of shares). In Salomon’s case, Mr Aron Salomon caused Salomon & Co Ltd to be incorporated and then sold his business to the company for about £39,000. Since the Companies Act 1862 (UK) stipulated that companies had to have at least seven shareholders, Aron, his wife and his five children subscribed for one share each. Aron and his two sons were the directors. Salomon & Co Ltd purchased Aron’s business in the following manner: • • • Aron received 20,000 shares (as if Aron had paid £20,000 for the shares and the company had then repaid £20,000 of its debt to Aron); The company paid some cash to Aron; and The balance of the purchase price was left outstanding as a (secured) debt due to Aron. (ie., Aron took £10,000 in debentures which charged the assets of the company).
The company subsequently encountered financial difficulties. Aron and his wife advanced some money to the company but that was not enough. Aron then borrowed £5,000 from Broderip and on-lent that money to the company. The company then issued debentures to Broderip (who became a secured creditor of the company). A liquidator was appointed to the company after it failed to pay interest on Broderip’s debentures, whereupon it became apparent that there was barely enough money to pay the (secured) debt to Broderip: in which case there would be nothing for unsecured creditors. The liquidator sought inter alia to set-aside the secured debt on the ground that Aron was really the principal (ie., the debtor). Vaughan Williams J found for the liquidator on the basis that: • • • • the company was not conducting the business in its own right but as agent for Aron; Aron (principal) had to indemnify the company (agent); Thus the agent was entitled to a lien over the principal’s assets in its possession (ie., Aron’s business); and The lien took priority over the debentures.
The Court of Appeal dismissed Aron’s appeal on the basis that while the legal effect of the transfer of his business could not be ignored, in virtue of the fact that the six other shareholders were not truly independent of Aron, the company was really conducting the business as Aron’s trustee.
The House of Lords reversed the courts below. Lord Halsbury LC observed that: Either the limited company was a legal entity or it was not. If it was, the business belonged to it and not to Mr Salomon. If it was not, there was no person and no thing to be an agent at all; and it is impossible to say at the same time that there is a company and there is not. Lord Macnaghten stated that: 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 in law the agent of the subscribers or trustee for them. (c) Company Contracts
Just as individuals can enter into contracts, so can companies. However, there is a complication in the analogy with natural persons because a contract requires consensus ad idem (ie., meeting of minds), and yet a company has no mind or will of its own. Thus, Professor Ford prefers to regard a company as a ‘legal entity’ rather than a ‘person’ (HAJ Ford et al, Principles of Corporations Law, 11th ed at p 105). However, companies can be regarded as persons in the limited sense that they can do everything that natural persons may do through others. Furthermore, companies may also be deemed to have knowledge or notice. The cases considered thus far also provide authority for the proposition that a company may contract with its shareholders and directors. Lee v Lee’s Air Farming Ltd  AC 12, develops this point. In that case, Mr Lee’s accountant formed a company (Lee’s Air Farming Ltd) in which: • • Of the 3,000 issued shares, Mr Lee held 2,999 shares and his solicitor took the other (as bare trustee for Mr Lee); and Mr Lee was the governing director with substantial powers.
The company contracted with farmers to perform aerial topdressing. Mr Lee worked for the company as a pilot and received a wage for that work. Mr Lee died in a work accident and his wife claimed on a workers compensation insurance policy that the company’s solicitor had taken out naming Mr Lee as an employee. The insurer denied liability on the ground that Mr Lee could not be a servant because he was a director of the company.
The Judicial Committee of the Privy Council firmly rejected the insurer’s argument. Lord Morris’ opinion is instructive: It cannot be suggested that, when engaged in the [topdressing work], the deceased was discharging his duties as governing director. Their Lordships find it impossible to resist the conclusion that the active aerial operations were performed because the deceased was in some contractual relationship with the respondent company. That relationship came about because the deceased, as one legal person, was willing to work for and make a contract with the respondent company which was another legal entity. A contractual relationship could only exist on the basis that there was a consensus between the two contracting parties. It was never suggested (nor, in their Lordship’s view, could it reasonably have been suggested) that the respondent company was a sham or a mere simulacrum. It is well established that the mere fact that someone is a director of a company is no impediment to his entering into a contract to serve the company. If, then, it be accepted that the respondent company was a legal entity, their Lordships see no reason to challenge the validity of any contractual obligations which were created between the respondent company and the deceased. [Lord Morris quoted Lord Halsbury LC’s judgment in Salomon’s case, that company ‘was a real thing’.] … Always assuming that the respondent company was not a sham, then the capacity of the respondent company to make a contract could not be impugned merely because the deceased was an agent of the respondent company in its negotiation [of Mr Lee’s contract of service].
Company Torts and Crimes
Although Lee v Lee’s Air Farming was a case of strict liability, it demonstrates the point that a company may be liable in tort or contract toward its directors and shareholders (and visa versa) – because it is a separate legal person. 3. LIFTING THE ‘VEIL OF INCORPORATION’
The fact that a company is treated as a separate legal person may work to the disadvantage of third parties. This is especially so in cases where creditors have negotiated with a natural person who then disclaims personal responsibility for the transaction on the basis that a company was the real actor and they were merely its conduit. It is, therefore, perhaps not surprising that the so-called ‘veil of incorporation’ may be penetrated in certain circumstances that are prescribed by the common law and statute. However, this does not mean that a company is suddenly not incorporated (companies remain incorporated until deregistered pursuant to CA, Ch 5A), but it does mean that the fact of its incorporation will be ignored for the purposes of the impugned transaction.
It is hard to predict whether a court will pierce the corporate veil and its occurrence is somewhat ‘freakish’. While it is difficult to rationalize the cases in which the veil will be lifted, it is useful to describe the legal categories under which they fall. In Pioneer Concrete Services Ltd v Yelnah Pty Ltd (1986) 5 NSWLR 254, Young J noted that the categories were: (a) (b) (c) (d) (e) (f) Agency; Fraud; Group enterprises; Trusts; Enemy; Tax; The [Corporations Act] itself.
Each category will be considered in turn. (a) Agency
While it was held in Salomon’s case that a company is does not necessarily act as agent for its majority shareholder, it does not follow that a company cannot act as an agent for its shareholder(s) or director(s). Since a company is a separate legal person, it could agree (expressly or impliedly) to act as agent. Hence, it is necessary to consider in each case whether there are facts that establish the relation of agency. In Smith, Stone & Knight Ltd v Birmingham Corporation  4 All ER 116, the respondent wanted to compulsorily acquire premises upon which a waste paper business was ostensibly carried on by Birmingham Waste Co Ltd (‘BWC’) - ‘ostensibly’ by BWC in the sense that BWC’s name appeared on stationery and on the premises. BWC was a wholly owned subsidiary of another company (‘P’) that owned the premises. The respondent would not have been liable to pay compensation to BWC for business disruption because its tenancy was terminable at will by P. However, P claimed that it really conducted the business and was therefore entitled to receive compensation. Atkinson J said the main question was whether BWC was carrying on the business for itself or for P. To resolve this issue Atkinson J posed six questions: • • Were the profits treated as profits of P? Did P appoint who would carry on the business? 10
• • • •
Was P the ‘head and brain’ of the business? Did P decide what to do and what capital to employ? Did P make profits from its skill and judgment? Was P in effectual and constant control?
Atkinson J decided to uphold P’s claim primarily because BWC did not have its own resources and the business had not been transferred to BWC. In Pioneer Concrete Services, Young J could not infer an agency between the parent and subsidiary because, unlike the subsidiary, the parent deliberately did not join in the promises in cl. 3 of the contract in that case. (b) Fraud
A court will not allow itself to be an instrument of fraud or illegality. Thus, Professor Ford observed that the main point in Gilford Motor Co v Horne  Ch 935, was that the veil of incorporation will be overlooked if there is an ‘unrebutted inference that one of the reasons for the creation of an intervening company was to evade a legal or fiduciary obligation.’ In Gilford Motor Company v Horne, H had promised in his contract of employment as managing director of G that he would not at any time solicit G’s clients. H subsequenlty formed a company (‘Z’) with his wife. Z then solicited G’s clients. The court held that the defendant’s assertion, that the business Z’s rather than H’s, was a mere ‘sham’ or ‘cloak’; especially since one of the reasons for Z’s creation was so that H could evade his covenant with G. The court therefore decided to overlook the fact of Z’s incorporation (or the fact that Z actually owned the business) and thus held H liable for breaching his contract with G. In Pioneer Concrete Services, Young J suggested (implicitly) that fraud would have to be either the ‘sole’ or ‘dominant’ purpose in order to invoke the principle in Gilford Motor Co.
The Court of Appeal observed in Adams v Cape Industries Plc  1 All ER 929 that: Our law, for better or worse, recognizes the creation of subsidiary companies, which though in a sense the creatures of their parent companies, will nevertheless
under the general law fall to be treated as separate legal entities with all the rights and liabilities which would normally attach to separate legal entities. Thus, as observed in Pioneer Concrete Services, a parent company normally cannot claim for itself the benefits of a contract made between its subsidiary and a third party, nor will it normally be liable under such a contract. In Briggs v James Hardie & Co Pty Ltd (1989) 16 NSWLR 549, Rogers AJA stated that, in the present state of the case law, it was not possible to say what evidence would warrant lifting of the corporate veil. It was not enough simply that the parent had control of the subsidiary. Note, however, that an increasing number of statutory provisions lift the corporate veil in group situations: vertical, horizontal or diagonal. Especially see: Corporations Act: ss 588V-588X (suspected insolvent subs.), and ss 259B, 259C, 260A (dealings in group shares etc – the group is treated as an economic unit). (d) Trusts
Companies may agree (expressly / impliedly) to act as trustee for its directors or shareholders, just as they may agree to act as agent. There might also be a constructive trust. (e) Enemy
R v Arnaud (1846) 9 QB 806 (non-enemy foreigners). (f) Tax
While companies are commonly utilised for legitimate tax-planning purposes, it would be naive to suppose that the courts would allow the corporate veil to be used as a device to ‘evade’ liability to contribute to the Revenue. Taxation legislation apprehends this stratagem and lifts the veil when it is used to ‘evade’ or ‘avoid’ tax liability. (g) Corporations Act
Since the essence of ‘limited liability’ is that a company’s debt is a company’s debt, directors usually are not responsible for the company’s debts. This rule invites abuse: if it is applied rigidly, then there is no pecuniary incentive for directors to ensure that the company can and will honour its obligations to pay a debt / perform a contract. While insolvency will be discussed later in this unit, note that s 588G casts personal liability (criminal and civil) upon directors for failing to prevent insolvent trading by their company. Section 588G(1) stipulates the conditions that activate s 588G: • The director was a director at the time when the company incurred the debt;
• • •
The company was insolvent at the time or pushed into insolvency; There were reasonable grounds to suspect the insolvency; and The debt was incurred at or after the commencement of the Act
Civil Penalty Provisions & Criminal Offences Company officers can only benefit from the protective shield of incorporation if they do not contravene the civil penalty provisions or commit criminal offences. Contravention of Civil Penalty Provisions: Section 1317E (1) states that a court must make a declaration of contravention if satisfied that a person has contravened one of the following provisions: • • • • • • Officer’s duties – ss 180(1), 181(1) and (2), 182 (1) and (2), 183(1) and (2); Related parties rules – s 209(2); Share capital transactions – ss 254L, 256D(3), 259F(2) and 260D(2); Financial reports – s 344(1); Insolvent trading – s 588G(2); Etc.
When a contravention order is made, the court may order a precuniary penalty of up to $200,000 if the contravention: • • • Materially prejudices the interests of the corporation …; or Materially prejudices the corporation’s ability to pay its creditors; or Is serious.
The court also may order a person to compensate a corporation for damage resulting from the contravention: s1317H. Section 1317J(1) states that ASIC may apply for: • • A declaration of contravention; A pecuniary penalty order; or
A compensation order.
Sections 1317J(2) allows the corporation to apply for a compensation order.
Criminal Offences: There is no criminal offence associated with breaching s180 (duty of care and diligence of director or officer). However, there may be a criminal offence if the breach of duty is accompanied by an element of recklessness or intentional dishonesty. For example, s184 states that a director or other officer commits an offence if they: (a) are reckless; or (b) are intentionally dishonest;
and fail to exercise their powers and discharge their duties: (c) (d) in good faith and in the best interests of the corporation; or for a proper purpose.
Furthermore, a person may commit a crime if they breach a particular section with dishonesty: eg, s209(3) [breaching s 208 with dishonesty]. Also see: s 1311 [General penalty provisions] and Schedule 3 – [penalties] up to $200,000 and 5 years imprisonment. Macaura v Northern Assurance Co Ltd  AC 619 appeared before the House Of Lords concerning the principle of lifting the corporate veil. Unusually, the request to do so was in this case made by the corporation's owner.
Mr Macaura owned the Killymoon estate in County Tyrone, Northern Ireland. He sold the timber there to Irish Canadian Sawmills Ltd for 42,000 fully paid up £1 shares, making him the whole owner (with nominees). Mr Macaura was also an unsecured creditor for £19,000. He got insurance policies - but in his own name, not the company's - with Northern Assurance covering for fire. Two weeks later, there was a fire. Northern Assurance refused to pay up because the timber was owned by the company, and that because the company was a separate legal entity, it did not need to pay Mr Macaura any money.
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Corporate personality - An Introduction
Discussion in 'Company law' started by Molineux, Jun 27, 2009. 1. Offline
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Likes Received: 42 Trophy Points: 28 Corporate Personality And Limited Liability By Clement Chigbo Brief explanation. Three leading cases are examined on corporate personality and limited liability. Corporate personality refers to the recognition by the state that certain organizations have legal personality. Historically in the United Kingdom, this meant that organizations such as religious orders and local authorities could hold property rights and could sue and be sued in their own right, without having to rely on the rights of the members of the organization. Over time, however, corporate personality came to be conferred on commercial ventures such as trading companies and roadway construction projects or parastatals (major statutory corporations) in which there was a public interest. By the mid nineteenth century, the difficulty involved in obtaining a grant of corporate status from parliament forced businesses to utilise the trust instrument to form "deed of settlement" companies. These companies were extremely complex legal entities that were sometimes used as instruments of fraud. In order to remedy this, a series of mid-
nineteenth century Companies Acts were passed, creating a process whereby ordinary individuals could easily form a registered company with limited liability. As a result, within a few decades, the company went from being the privileged of a few to being almost a right. Note the differences between corporate personality and limited liability. A company once incorporated becomes a separate legal entity or personality and the liability of the members are said to be limited. But there is a distinction between the two. Limited liability is the logical consequence of the existence of a separate personality. But however, that just as humans can have restrictions imposed on their legal personality (for example, in the case of children) so a company can have legal personality without limited liability if that is how it is conferred by statute. A company may still be formed today, that is, as registered unlimited company without limited liability… See Companies Act 1992 Section 3(1) which provides that subject to Subsection (2) two or more persons may incorporate a company with or without limited liability by signing a memorandum and submitting it to the Registrar of Companies. The logic of separate personality and limited liability was not tested to its full extent until the late nineteenth century as exemplified by the case of Salomon v Salomon & Co. (1897) A C 22. In the abovementioned case, Mr. Salomon carried on business as a leather merchant. In 1892 he formed the company Salomon & Co. Ltd. Mr. Salomon, his wife and five of his children held one share each in the company. The members of the family held the shares for Mr. Salomon because the Companies Acts required at that time that there be seven shareholders. Mr. Salomon was also the manager of the company. The newly incorporated company purchased the sole trading leather business. The leather business was valued by Mr. Salomon at E 39,000.00. This was not an attempt at fair valuation rather it represented Mr. Salomon’s confidence in the continued success of the business. The price was paid in E10,000.00 worth of debentures giving a charge over all the company’s assets, E20,000.00 in E1 shares and E9,000.00 cash. Mr. Salomon also at this point paid off all the sole trading business creditors in full. Mr. Salomon also held E20,000.00 shares in the Company and his family held the six remaining shares. He was because of the debenture, a secured creditor. Note that Debenture is in the nature or form of a loan capital under which the debenture holder lends money to the company at fixed rate of return. Therefore, Mr. Salomon’s personal liability for the debts of the business had changed completely from unlimited liability (as a sole trader) to limited liability (as a shareholder in the company). Not only was Mr. Salomon no longer liable for the debts of the company but he had also, as managing director of the company, granted himself a secured charge over all the company’s assets. Thus, if the company failed, not only would Mr. Salomon have no liability for the debts of the company, but whatever assets were left would be claimed by him to pay off the company’s debt to him …
However, things did not go well for the leather business and within a year Mr. Salomon had to sell his debentures to save the business. This did not have the desired effect and the company was placed in insolvent liquidation. The liquidator, on behalf of the unsecured creditors, alleged that the company was but a sham and a mere "alias" or agent for Mr. Salomon and that Mr. Salomon was therefore personally liable for the debts of the company. The Court of Appeal agreed, finding that the shareholders had to be a bona fide association who intended to go into business and not just hold shares to comply with the Companies Acts. Famously, the House of Lords disagreed, finding that the fact that some of the shareholders only held shares as a technicality was irrelevant; the machinery of the Companies Acts could be used by an individual to carry on what is, in economic reality, his/her business. They also emphasized that a company formed in compliance with the regulations of the Companies Act is a separate person and not per se the agent or trustees of its controller. The decision also confirmed that the use of debentures instead of shares can further protect investors. From this point on, the twin concepts of separate personality and limited liability became pillars of United Kingdom Company Law which courts have largely been keen to maintain. It is also interesting to note that among the principal reasons, which induce persons to form, private companies are the desire to avoid the risk of bankruptcy and the increased facility afforded for borrowing money. According to Palmer in his treatise on company law, a trade can be carried on with limited liability, and without exposing the persons interested in it in the event of failure to the harsh provisions of the bankruptcy law. Besides, a company too, can raise money on debentures, which an ordinary trader cannot do. Any member of a company, acting in good faith, is as much entitled to take and hold the company’s debentures as any outside creditor. See also the observation of Lord MacNaghten of the House of Lords in Salomon v. Salomon (which seems to illustrate the concept of separate personality and limited liability). The learned law Lord observed, "The unsecured creditors of A Salomon and Co. Ltd. may be entitled to sympathy, but they have only themselves to blame for their misfortunes. They trusted the company, I suppose, because they had long dealt with Mr. Salomon, and he had always paid his way; but they had full notice that they were no longer dealing with an individual." Hence the Learned Lord MacNaghten emphasized the axiom that the company is different from Mr. Salomon, the controller of the company. The case of Macaura v. Northern Assurance Co. (1925) AC 619 seems to have served as vivid illustration of the impact of separate personality and limited liability. Mr. Macaura owned an estate and some timber. He agreed to sell all the timber on the estate in return for the entire issued share capital of Irish Canadian Saw Mills Ltd. The timber, which amounted to almost the entire assets of the company, was then stored on the estate. On 6th February 1922 Macaura insured the timber in his own name. Two weeks later a fire destroyed all the timber on the estate. Mr. Macaura tried to claim under
the insurance. The Insurance Company refused to pay arguing that he had no insurable interest in the timber as the timer belonged to the company. Allegations of fraud were also made against Mr. Macaura but never proven. Eventually in 1925 the issue arrived before the House of Lords who found that the timber belonged to the company and not to Mr. Macaura. Even though he owned all the shares in the company, Mr. Macaura had no insurable interest in the property of it. Just as corporate personality facilitates limited liability by making the debts belong to the corporation, it also means that the company’s asset belong to it and not to the shareholders. See also the case of Lee v Lee Air Farming (1961) AC 12 which is another good illustration of the concept of corporate personality and limited liability In the above mentioned case, Lee, the appellant’s late husband, had formed the respondent company to carry on his business of spreading fertilisers on farmland (top dressing) from air. He held 2,999 of its 3000 shares, and was by its articles of association appointed sole governing director and also (pursuant to the articles) employed at a salary as its chief pilot. He was killed in as aircraft crash while flying for the company. If he was a worker (defined as "any person who has entered into or works under a contract of service… with an employer… whether remunerated by wages, salary or otherwise) then his widow was entitled to be paid compensation by his employer under the Workers Compensations Act 1922 (NZ). The company, as required by statute, was insured against liability to pay its workers such compensation. Mr. Lee appealed successfully against the ruling of the Court of appeal of New Zealand that Lee could not be a "worker" when he was in effect also the employer. The Privy Council held having cited the decision in Salomon v. Salomon with approval that there is no reason to deny the possibility of a contractual relationship being created as between the deceased and the company. Hence a director of a company may properly enter into a service agreement with his company. Therefore whether the deceased was a worker within the meaning of the "Workers Compensation Act 1922 and its amendment and whether he was a person who had entered into or worked under a contract of service with an employer was answered in the affirmative by their Lordships. (i.e. the deceased was a worker who entered into a contract of service with an employer). The company and the deceased were separate legal entities. In essence a company may make a valid and effective contract with one of its members. It is possible for a person to be at the same time wholly in control of a company (as its principal shareholder and sole director) and an employee of that company. Note: Although Lee’s case is undoubtedly correct as a ruling in company law and in particular as the authority for the proposition slated above, however the question whether a person should be regarded as an "employee" of a company which he can control as a director or major shareholder may not always be clear-cut-for instance,
in the context of the legislation relating to redundancy payments, the court may not consider that such a person is to be treated as an "employee" entitled to compensation for unfair or wrongful dismissal. See Buchan v Secretary of State For Trade and Industry (1997) 1 RLR 80. See this issue discussed in the case of Secretary of State For Trade and Industry v Bottril (1999) 1 CR 592 CA. Note further that the property of a company belongs to it and not to its members. Neither a shareholder nor a creditor of a company (unless a secured creditor) has an insurable interest in the asset of the company. The Macaura decision is a very good example of the separation of shareholders property from the company’s. Mr. Macaura, despite holding all the shares in the company only "owned" his shares, and not the company’s property. Those shares represented all the participation rights in the company, which he could sell if he wished. a share is in no way a representation of the fractional value of the company’s property. The company as a separate legal entity owns its own property and there is no legal connection between a share in the company and the company’s property. Shareholders generally benefit from this because it facilitated limited liability, as the company also owns its own debts. Rest assured that the company is treated at law as if it was a separate personality from its members. This no doubt facilitates the limitation of the members’ liability, as the company is responsible for its own debts. Molineux, Jun 27, 2009 #1 (You must log in or sign up to reply here.)
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Friday, September 26, 2008
THE DOCTRINE OF CORPORATE PERSONALITY
Introduction Hello there my dear students.Today I want to touch on the doctrine of corporate personality.In this chapter we explore the related concepts of corporate legal personality and limited liability. These concepts are central to your developing an understanding of company law and it is essential that you take time here to absorb these fundamental principles. Corporate personality Corporate personality refers to the fact that as far as the law is concerned a company personality really exists apart and different from its owners. As a result of this, a company can sue and be sued in its own name, hold its own property and crucially – be liable for its own debts. It is this concept that enables limited liability for shareholders to occur as the debts belong to the legal entity of the company and not to the shareholders in that company. The history of corporate personality Corporate legal personality arose from the activities of organisations such as religious orders and local authorities which were granted rights by the government to hold property and sue and be sued in their own right and not to have to rely on the rights of the members behind the organisation. Over time the concept began to be applied to commercial ventures with a public interest element such as rail building ventures and colonial trading businesses. However, modern company law only began in the midnineteenth century when a series of Companies Acts were passed which allowed ordinary individuals to form registered companies with limited liability. The way in which corporate personality and limited liability link together is best expressed by examining the key 21
cases. Salomon v Salomon & Co. Salomon v Salomon & Co.  AC 22, this assumption proved to be mistaken. Mr Salomon carried on a business as a leather merchant. In 1892 he formed the company Salomon & Co. Ltd. Mr Salomon, his wife and five of his children held one share each in the company. The members of the family held the shares for Mr Salomon because the Companies Acts required at that time that there be seven shareholders. Mr Salomon was also the Managing Director of the company. The newly incorporated company purchased the soletrading leather business. The leather business was valued by MrSalomon at £39,000. This was not an attempt at a fair valuation; rather it represented Mr Salomon’s confidence in the continued success of the business. The price was paid in £10,000 worth of debentures (a debenture is a written acknowledgement of debt like a mortgage – see Chapter 7) giving a charge over all the company’s assets (this means the debt is secured over the company’s assets and Mr Salomon could, if he is not repaid his debt, take the company’s assets and sell them to get his money back), plus £20,000 in £1 shares and £9,000 cash. Mr Salomon also at this point paid off all the sole trading business creditors in full. Mr Salomon thus held 20,001 shares in the company, with his family holding the six remaining shares. He was also, because of the debenture, a secured creditor. However, things did not go well for the leather business and within a year Mr Salomon had to sell his debenture to save the business. This did not have the desired effect and the company was placed in insolvent liquidation (i.e. it had too little money to pay its debts) and a liquidator was appointed (a court appointed official who sells off the remaining assets and distributes the proceeds to those who are owed money by the company, see Chapter 16). The liquidator alleged that the company was but a sham and a mere ‘alias’ or agent for Mr Salomon and that Mr Salomon was therefore personally liable for the debts of the company. The Court of Appeal agreed, finding that the shareholders had to be a bona fide association who intended to go into business and not just hold shares to comply with the Companies Acts. The House of Lords disagreed and found that: the fact that some of the shareholders are only holding shares as a technicality was irrelevant; the registration procedure could be used by an individual to carry on what was in effect aone-man business a company formed in compliance with the regulations of the Companies Acts is a separate person and not the agent or trustee of its controller. As a result, the debts of the company were its own and not those of the members. The members’ liability was limited to the amount prescribed in the Companies Act – i.e. the amount they invested. The decision also confirmed that the use of debentures instead of shares can further protect investors. Read Salomon v Salomon & Co. (1897) AC 22. (a) Describe the key effects of the change in status from a sole trader to a limited
company for Mr Salomon. (b) What are the key principles that we can draw from the case? (c) Should Mr Salomon have been liable for the debts of the company? In Macaura v Northern Assurance Co.  AC 619 Mr Macaura owned an estate and some timber.He agreed to sell all the timber on the estate in return for the entire issued share capital of Irish Canadian Saw Mills Ltd. The timber, which amounted to almost the entire assets of the company, wasthen stored on the estate. On 6 February 1922 Mr Macaura insured the timber in his own name. Two weeks later a fire destroyed allthe timber on the estate. Mr Macaura tried to claim under theinsurance policy. The insurance company refused to pay outarguing that he had no insurable interest in the timber as the timber belonged to the company. Allegations of fraud were also made against Mr Macaura but never proven. Eventually in 1925 theissue arrived before the House of Lords who found that: The timber belonged to the company and not Mr Macaura Mr Macaura, even though he owned all the shares in the company, had no insurable interest in the property of the company just as corporate personality facilitates limited liability by having the debts belong to the corporation and not the members, it also means that the company’s assets belong to it and not to the shareholders. More modern examples of the Salomon principle and the Macaura problem can be seen in cases such as Barings Plc (In Liquidation) v Coopers & Lybrand (No.4)  2 BCLC 364. In that case a loss suffered by a parent company as a result of a loss at its subsidiary (a company in which it held all the shares) was not actionable by the parent – the subsidiary was the proper plaintiff. In essence you can’t have it both ways – limited liability has huge advantages for shareholders but it also means that the company is a separate legal entity with its own property, rights and obligations. In Lee v Lee’s Air Farming  AC 12. Mr Lee incorporated a company, Lee’s Air Farming Limited, in August 1954 in which he owned all the shares. Mr Lee was also the sole ‘Governing Director’ for life. Thus, as with Mr Salomon, he wasin essence a sole trader who now operated through a corporation.Mr Lee was also employed as chief pilot of the company. In March, 1956, while Mr Lee was working, the company plane he was flying stalled and crashed. Mr Lee was killed in the crash leaving a widow and four infant children.The company as part of its statutory obligations had been paying an insurance policy to cover claims brought under the Workers’Compensation Act. The widow claimed she was entitled to compensation under the Act as the widow of a ‘worker’. The issue went first to the New Zealand Court of Appeal who found that he was not a ‘worker’
within the meaning of the Act and so no compensation was payable. The case was appealed to the Privy Council in London. They found that: the company and Mr Lee were distinct legal entities and therefore capable of entering into legal relations with one another as such they had entered into a contractual relationship for him to be employed as the chief pilot of the company he could in his role of Governing Director give himself order as chief pilot. It was therefore a master and servant relationship and as such he fitted the definition of ‘worker’ under the Act. The widow was therefore entitled to compensation. Separate legal personality and limited liability are not the same thing. Limited liability is the logical consequence of the existence of a separate personality. The legal existence of a company (corporation) means it can be responsible for its own debts. The shareholders will lose their initial investment in the company but they will not be responsible for the debts of the company. Just as humans can have restrictions imposed on their legal personality (as in the case of children) a company can have legal personality without limited liability if that is how it is conferred by the statute. Posted by A.VIJAYCHANDRAN at 6:09 AM
Nic said... Dear Mr Vijay, This is a very well written piece which deals with the basic concepts of company law. If I could trouble you, in lieu of the fact that my exams are around the corner, could you make a post on how one could go about answering a problem question relating to lifting the veil and corporate personality. Nic May 11, 2010 2:12 PM dissertation writing said... I have been visiting various blogs for my dissertation writing research. I have found your blog to be quite useful. Keep updating your blog with valuable information... Regards August 3, 2010 12:44 AM Eunice Simuli said...
Dear Mr. Vijay, Thank you for this well written piece of work. It excites me greatly to know that I can easily find information that will make it very easy for me in my studies. Keep it up please! Eunice. February 27, 2011 11:42 AM Post a Comment
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A.VIJAYCHANDRAN Kuala Lumpur, Selangor, Malaysia Origin- Penang.Came to KL in 80's to study theology.Threw away my religious books after 4 years to read Law. View my complete profile