CHAPTER 3 LEGAL PERSONALITY

CHAPTER 3
LEGAL PERSONALITY

LECTURER: N. NEWAZ KARIM (ACCA AFFILIATE)

 CHAPTER 3 LEGAL PERSONALITY
WHATS IS LEAGAL PERSONALITY?

All the adults can file a suit as we all are individuals in the eyes of law. A child can also file a suit but
his or her guardian has to complete the process.

The companies or corporations also have the right to sue others and they can also be sued.

The corporations can buy assets in its name. It enjoys these rights because in the eyes of law, it is
also regarded as an individual person. This is known as legal personality/ artificial
personality/ corporate personality. For having this right, the company is not winded up even if
all the shareholders die.

In a sole proprietorship or partnership business, the owners and the business cannot be separated
in the eyes of law. For this reason, the owners have unlimited liability except in limited liability
partnerships, which is a very rare type of business in reality.

The biggest difference between company and other type of organizations is that a company has a
separate legal identity from its owners. A company, by its representatives, can sign contracts in its
own name and the owners’ liability in case of liquidation of the company is limited to the amount of
money they invested to the company whereas in sole proprietorships or partnerships, the owners
are held liable for the action of the business.

In common law, this principle is known as corporate personality. This principle was established
in the case of salomon vs. Salomon ltd. The company went into liquidation but the owner, who
owned almost all the shares in the company, was not held liable for the debts of the company
because the company was considered as a separate legal entity.

Facts from the case:

Salomon transferred his business of boot making, initially run as a sole proprietorship, to a company
(Salomon Ltd.), incorporated with members comprising of himself and his family.

The price for such transfer was paid to Salomon by way of shares, and debentures having a floating
charge (security against debt) on the assets of the company.

Later, when the company’s business failed and it went into liquidation, Salomon’s right of recovery
(secured through floating charge) against the debentures stood a prior to the claims of unsecured
creditors, who would, thus, have recovered nothing from the liquidation proceeds.

To avoid such alleged unjust exclusion, the liquidator, on behalf of the unsecured creditors, alleged
that the company was sham, was essentially an agent of Salomon, and therefore, Salomon being the
principal, was personally liable for its debt. In other words, the liquidator sought to overlook the
separate personality of Salomon Ltd., distinct from its member Salomon, so as to make Salomon
personally liable for the company’s debt as if he continued to conduct the business as a sole trader.

LECTURER: N. NEWAZ KARIM (ACCA AFFILIATE)

 CHAPTER 3 LEGAL PERSONALITY

Issues from the case:

The case concerned claims of certain unsecured creditors in the liquidation process of Salomon Ltd., a
company in which Salomon was the majority shareholder, and accordingly, was sought to be made
personally liable for the company’s debt. Hence, the issue was whether, regardless of the separate
legal identity of a company, a shareholder could be held liable for its debt, over and above the
capital contribution, so as to expose such member to unlimited personal liability.

What was held in the eyes of Law?

The Court of Appeal (Lower Court), declaring the company to be a myth, reasoned that Salomon had
incorporated the company contrary to the true intent of the then Companies Act, 1862, and that the
latter had conducted the business as an agent of Salomon, who should, therefore, be responsible for the
debt incurred in the course of such agency.

The House of Lords (A higher Court back then), however, upon re-appeal, reversed the above ruling,
and unanimously held that, as the company was duly incorporated, it is an independent person with
its rights and liabilities appropriate to itself, and that “the motives of those who took part in the
promotion of the company are absolutely irrelevant in discussing what those rights and liabilities are”.
Thus, the legal fiction of “corporate veil” between the company and its owners/controllers4 was firmly
created by the Salomon case.

CONSEQUENCES OF CORPORATE PERSONALITY

Limited Liability Legal Capacity Perpetual Existence

Liability limited to the face value Can sue and be sued by For having corporate personality, a
of shares unless otherwise agreed others. company is not closed at the death
Can buy assets in its of shareholders
own name

THE VEIL OF INCORPORATION

As already mentioned, a company has an artificial personality. For this reason, the general public
can see the company, not the owners or members behind managing it. This is called the Veil of
Incorporation

it is lifted under certain circumstances by statutes to enforce the law, to prevent the evasion of
obligations and in certain situations where companies trade as a group.

LECTURER: N. NEWAZ KARIM (ACCA AFFILIATE)

 CHAPTER 3 LEGAL PERSONALITY
LIFTING THE VEIL BY STATUTE: TO ENFORCE THE LAW

• If a public company commences trading without obtaining a trading certificate, the

directors become personally liable for any loss or damage suffered by a third party for any
transactions entered into by the company.

• Persons, usually the directors, who have knowingly committed fraudulent or wrongful trading,
are personally liable under civil law, for the debts and other liabilities of the company resulting
from such trading.

• If a director(s), who is not allowed to get involved in the management of a company under
the company Directors Disqualification Act 1986, participates in the management of a
company, he will be jointly and severally liable, along with the other directors, for the debts
of the company.

• If the director of a company that goes into insolvent liquidation, becomes involved with the
directing, managing or promoting of a business which as an identical name or a name
similar enough to suggest that it has a connection to the original company, he is
considered to have committed a criminal offence under The Insolvency Act 1986.

LIFTING THE VEIL: TO PREVENT EVASION OF OBLIGATIONS

• A court may decide to ignore the distinction between a company and its members and directors,
especially if they use the distinction to evade their existing legal obligations. This was
established in the case of Gilford motor co ltd vs. Horne

Facts from the case:

Mr Horne was a former managing director of Gilford Motor Home Co Ltd (Gilford). His employment
contract prevented him from attempting to solicit Gilford’s customers in the event that Horne left
Gilford’s employ. Horne was fired and he subsequently set up a competing company which undercut
Gilford’s prices. Gilford did not have any legal restraints upon Horne’s company, only Horne himself.
Gilford commenced proceedings against Horne individually, claiming that Horne’s company was an
attempt to evade legal obligation (not soliciting customers).

Issues from the case:

Had Horne violated his non-compete clause by setting up his competing company?

What was held in the eyes of Law?

The English Court of Appeal held that the company was set up to evade Horne’s contractual
obligations. The Court “pierced the corporate veil” and ordered an injunction against Horne. Courts
can “pierce the corporate veil” if a company is simply a mere device to evade legal obligations.

LECTURER: N. NEWAZ KARIM (ACCA AFFILIATE)

 CHAPTER 3 LEGAL PERSONALITY
• In time of war, a company is not allowed to trade with “Enemy Aliens”. The court may lift the
veil and hold the directors personally liable, if the company is suspected to be controlled by
“aliens”, even if it is registered in the United Kingdom.

• The veil may also be lifted and the directors held personally liable if the directors ignore
the separate legal personality of two companies and transfer assets from one to the other
in order to avoid an existing liability. This was established in the case of re vs. H and other.

• The court may also lift the veil if it is being used to conceal the nationality of a company in
order to avoid taxes. This was established in the case of unit Construction co ltd vs. Bullock.

• If the members (Shareholders/Ownners) of a company, who are also actively involved in

the management, makes an application to liquidate the company on the “just and
equitable” ground under the insolvency act 1986, the court may lift the veil to reveal the
company as a partnership. The members are then treated as partners and held personally
liable for the debts of the company. This was established in the case of Ebrahimi vs. Westbourne
galleries ltd.

THANK YOU!

LECTURER: N. NEWAZ KARIM (ACCA AFFILIATE)

 CHAPTER 3 LEGAL PERSONALITY

1. Describe what is meant by the term “Legal Personality” (4 MARKS)

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2. State THREE situations where the Veil of Incorporation is lifted by statute to enforce the law?
(6 MARKS)

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3. State FOUR situations where the Veil of Incorporation is lifted to prevent evasion of
obligations? (8 MARKS)

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LECTURER: N. NEWAZ KARIM (ACCA AFFILIATE)