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Law 200

Faculty: Shd (Shaheen Ahmed)


Question: The company is at law a different person altogether from its members.
The company is not in law the agency of the subscribers or trustees for them.
explain the statement with reference to the leading cases.

Answer: The given statement is basically the concise form of the Veil of Incorporation
which in its elaborated form takes the following features within A company once
incorporated becomes a legal personality, a juristic entity, separate and distinct from its
members and shareholders and capable of having its own rights, duties and obligation and
can sue or be sued in its own name. This is commonly referred to as the doctrine or principle
of corporate personality and it carries with it the concept of limited liability which ordinarily
flows from the aforementioned doctrine of corporate personality. No case illustrated the
above principles better than the noted House of Lords decision in Salomon v. Salomon.
However, in some circumstances, the courts have intervened to disregard or ignore the
doctrine of corporate personality and limited liability especially in dealing with group
companies and subsidiaries and where the corporate form is being used as a vehicle to
perpetrate fraud or as a "mere faade concealing the true facts." In this article, we will
examine the concept of lifting the veil and the circumstances where the court may "pierce" or
"lift" the veil of incorporation.
Case Analysis: The Salomon principle has stood the test of time because it has meant that
corporations do have practical utility. As a separate legal entity subject to limited liability and
defined by share transferability, perpetual existence, flexible financing methods, specialised
management, majority rule and the other attributes or consequences of incorporation, the
corporation has many economically and socially beneficial functions.
Primarily, a corporation enables the investing public to share in the profits of an enterprise
without being involved in management. It also enables a single trader or a small partnership

to carry on a business. Similarly, a corporation provides a structure for joint venture; holding
family assets; continuing trusteeship; fund management; corporatised government enterprise;
and, the co-enjoyment of property. Marshalling participants in large commercial enterprises
and acting as a nominee to hold the legal title to assets are two other important functions.
At its most particular level, however, the decision of the House of Lords in Salomon v
Salomon & Co Ltd was not a good decision. Professor Kahn-Freund went so far as to
describe it as "calamitous". Salomon's case established the independent corporate existence of
a registered company, a principle of the greatest importance in company law. But if applied
inflexibly, as was the case in Salomon, it can shield parties unreasonably, to the detriment of
persons dealing with companies.
Corporate personality is essentially a metaphorical use of language clothing the formal group
with a single legal identity by analogy with a natural person... [But] As Cardozo J said in the
American case of Berkey v Third Avenue Rly [(1926) 244 NY 84 at 94-5]: "metaphors in law
are to be narrowly watched, for starting as devices to liberate thought, they often end by
enslaving it."
In stressing the independent nature of corporate personality, the House of Lords legitimised
the usage of the corporate form by individual traders and small partnerships: private
enterprises which do not seek to raise capital from the public but are anxious to interpose an
entity between themselves and their creditors. The Law Lords concluded that once registered
in a manner required by the Act, a company forms a new legal entity separate from the
shareholders, even where there is only a bare compliance with the provisions of the Act and
where all, or nearly all, of the company's issued shares are held by one person. Furthermore,
the Court held that it was possible for traders not merely to limit their liability to the capital
which they invested in the enterprise but even to elude any serious risk to the major part of
that by subscribing for debentures rather than shares.
As noted in The Law Quarterly Review, Salomon's case was not about "a dry point of
construction". The House of Lords had sanctioned a change in ideas about what the company
was and about the uses to which it could be put. It gave priority to the separate identity of the
legal form and essentially ignored the economic reality of a one-person company. Basically,
Goulding explains, the reason for criticism of Salomon's case is two-fold. First, the decision
gives even apparently honest incorporators the benefit of limited liability in circumstances in
which it is not necessary in order to encourage them to initiate or carry on their trade or
business. Second, the opportunities that the decision affords to unscrupulous promoters of

private companies to abuse the advantages that the Corporations Act gives them by achieving
a "wafer-thin" incorporation of an undercapitalised company.
First, limited liability attracts small traders to the corporate form not because it represents an
effective device with which to raise capital, but because it gives them access to an avenue via
which to escape the "tyranny of unlimited liability". Criticisms of limited liability are
addressed at its impact on creditors and on society at large.
The principle is that a limited company's creditors must look at the capital, the limited fund,
and that only. Limited liability discourages shareholders from monitoring and controlling
their company's commercial ventures. The company's creditors bear the burden of the risks
inherent in dealing with limited liability companies. At issue is whether it is right that limited
liability should operate to restrict the size of the company's capital. Different types of
creditors have different capacities to protect themselves against these risks. While banks and
similar financial creditors easily overcome such risks, the same cannot be said of trade
creditors, employees and tort creditors. Because trade creditors rarely insist on security before
they supply goods on credit, they bear a considerable part of the risk of corporate insolvency.
Employees are in an even more precarious position. In stark contrast to finance and trade
creditors, employees have no opportunity to obtain security or diversify the risk of their
corporate employer's insolvency. Moreover, the majority of employees has minimal
information about their employer's financial standing (but see the Corporations Act). While
contract creditors bear a degree of risk when they deal with a limited liability company, they
at least enter into the contract by their own will. This is not so for a company's tort creditors.
Victims of torts committed by a company bear an uncompensated risk in case of the
company's insolvency.
From a more technical perspective, the economic benefits brought about by limited liability
are absent with respect to closely held or private companies. The reduction in monitoring
costs, for example, is irrelevant because owners and managers are one and the same.
Moreover, the benefit of fostering an efficient market for shares through limited liability does
not apply as there is no market for the shares of closely held companies. Furthermore, limited
liability encourages such companies to take excessive risks because the directors of closely
held companies have more to gain personally by shifting the risk of commercial collapse to
corporate creditors than is the case with public companies' directors.
Second, ever since the House of Lords handed down its decision in Salomon's case, legal
doctrine regards each corporation as a separate legal entity. When coupled with the
consequent attribute of limited liability, the Salomon principle provides an ideal vehicle for

fraud. Because of its malleability and facility for protecting directors and members against
the claims of creditors, the corporate form has been responsible for the development of many
different forms of fraudulent or anti-social activity. Fraud, in this context, cannot be precisely
defined, but two tangible illustrations may elucidate the concept.
What is colloquially known as the "$2 company" is one notable example of corporate fraud.
This involves the situation where a small group of persons set up a limited liability company
that is undercapitalised. The owners then cause the corporation to incur large debts in its own
name, with little prospect of being able to repay the loans. When the company's creditors seek
repayment of the debts, the owners argue that because the company as a separate legal person
owes the debt, then neither the directors nor the members are liable.
Another instance of corporate fraud involves "bottom of the harbour" schemes. Here, all of
the assets of one corporation that is about to incur a large income tax liability are transferred
to a new corporation incorporated for this purpose. This transfer is channelled through a
confusing series of transactions involving other corporations and overseas corporate havens
in an attempt to conceal the real design of the scheme. The original corporation might also
change its name and address, and create false documentation so as to defeat the efforts of
regulatory investigators. If investigators trace this shell of a corporation, they often find that
straw men have been appointed in place of the original directors. The new corporation, now
asset rich, is operated merely to fund further schemes for the people who have formed it,
including activities as varied as the granting of unsecured interest-free loans by the
corporation to the directors or to companies in which they have an interest; the use of
corporate capital for the personal living expenses of directors or major shareholders; the
payment of astronomical fees and other payments for management services; and, further tax
minimisation by methods such as unrealistic asset valuations. Often, such schemes involve
undercapitalised corporations carrying on a business as trustee for other persons as
beneficiaries. By combining the corporate form with the malleability of the trust structure,
creditors might be kept at even greater distance from those who manage the enterprise.
Conclusion: The question of whether the negative aspects of the decision in Salomon's case
outweigh the good ones is best left unanswered for it is far too broad. One is inclined
towards the view that the principle of separate legal entity established in Salomon's
case has been instrumental in the development of modern capitalism and the immense
social and economic wealth which it has generated. The House of Lords extended the
principle so far as to cover small private enterprises. This move has had several

negative consequences over time. However, it is also true that these have been largely
neutralised by joint legislative and judicial action.
Indeed, "the legislature can forge a sledgehammer capable of cracking open the corporate
shell." And, even without statutory assistance, the courts have often been ready to draw aside
the veil and impose legal liability on members and directors where to apply the Salomon
principle strictly would lead to injustice, inconvenience or damage to government finances.
Similarly, it should be pointed out that, following Salomon's case, all Australian jurisdictions,
in a desire to ameliorate legal facilities for small commercial enterprises, introduced
provisions for private companies into their corporate law. Experience since Salomon's case
demonstrated that there was no reason why the benefit of limited liability should apply only
to groups of business entrepreneurs. The Corporations Act takes this to its logical conclusion
and sanctions the registration of one-person companies. In 1995, the First Corporate Law
Simplification Act amended the Corporations Act to permit a proprietary company to be set
up with one or more shareholders. Under another amendment, the minimum number of
directors needed to be designated in a proprietary company was cut from two to one.
Moreover, the Corporations Act states that any sort of company, not just a proprietary
company, may be established with only one member and may continue to exist with only one
member (section 114). It would appear then that the overall balance is positive and that the
decision of the House of Lords in Salomon v Salomon & Co Ltd was a good decision.
Despite numerous sophisticated attempts in recent years at providing theories which explain
company law, it is noteworthy that we have not yet fully understood the essence of the
corporate being. It will, suffice to say, that if three persons incorporate a company, the
company will become a fourth person separate and different from these three persons
individually or collectively. However when the company or corporate form is a sham or a
mere faade concealing the true facts, the veil of corporate personality can be torn aside.

Web References:
1. Lifting The Veil Of Incorporation by Clement Chigbo (The Bahama Journal Website)
2. A Two-Edged Sword: Salomon and the Separate Legal Entity Doctrine by Gonzalo
Villalta Puig (Murdoch University Electronic Journal of Law Website)
1. Company Law by Dr. M Zahir
2. Company Law by Sen Mitra & N. Dhar