The Economic Connection between Companies within the Same Group and English Law - Essay Example

? In spite of the obvious economic connection between companies within the same group, English law has steadfastly maintained its policy of treating such companies as distinct legal entities.”- Consider the need for reform Name Law Institution Tutor Date Introduction The English Company law asserts that companies in the United Kingdom should be treated as separate legal entities from their owners. Different cases have plagued the English law culminating to the creation of different names that are aimed at delineating the separate legal entity that exists between companies within the same group. In the case of I.R.C. v Sansom1 the term polite invective has been used to describe the issue of legal entity between corporations. See also Broderip v Salomon2 where the concept of separate legal entity has been defined as a myth and a fiction. Moreover, in the case of Salomom v Salomon & Co3 the separate legal entitiy of companies has been described as a pretended association while in4it has been defines as a bubble. Legal abstraction has also been used as a term to describe the legal entity of corporations in the case of Continental Tyre & Rubber C. (G.B.) Ltd. V Daimler Co. Ltd5. See also Houghton & Co. v Nothard, Lowe and Wills Ltd6 where the legal entity concept was described as an abstract conception and as a cloak in the case of Gilford Motor Co. Ltd v Horne7. These cases reveal that the concept of separate legal entity has been widely used in the United Kingdom and thus necessitating the need to discuss this statement. Whether there is need for reforms as pertains to the treating of companies within the same group as legal entities will be delineated. The Essence of Treating Companies within the Same Group as Distinct Legal Entities Distinct legal entity in companies is treated as a multifaceted concept in the United Kingdom and there are various principles that need to be adhered to comprehend this concept. Companies as legal entities that separate from their owners, consumes and third parties do not exist in a vacuum and are thus anchored on three major principles. The first principle aims at assessing to what extent the company’s legal competence prevails. This is aimed at evaluating the legal competence of a company in achieving the legal requirements. Secondly, the nature of the legal capacity of the corporation needs to be identified for the separate legal clause to apply sufficiently. Finally, the manner in which the company will exercise its distinct legal entity needs also to be evaluated. It is documented that until the three principles are addressed competently, the issue of companies as separate legal entities will always appear hazy and seems like a mirage.8 Principle 1: Extent of the Legal capacity of a Company The legal capacity of an individual is very distinct from the legal capacity of a Company. A company in comparison to an individual faces restrictions as pertains to the extent of liabilities and rights that are accorded to the company compared to an individual. According to the case of Ashbury Railway Carriage and iron Co. v Riche9 it was avowed that the law has powers as pertains to the circumscription and imposing limitations on the company and the performance of activities. This has in turn shifted form a theoretical to a practical perspective as in the case of Daimler Co. Ltd. V Continental Tyre & Rubber Co. (G. B.) Ltd10 where a company was defined as a generation of law made for the management of the company, property holding, and the involvement of individuals in business transactions. this can further be elaborated in two ways: one way being that by the law requiring companies to declare their objects during the incorporation stage, the companies in turn adopt a restricted capacity. Consequently, upon adoption of a restricted capacity, the law is given the mandate of imposing its legal restrictions on the company. This asserts that there is a greater legal capacity of a company hence explaining why companies are treated as separate legal entities. During the early development of English Company law, companies were perceived to have powers similar to those of individuals. This meant that a charted company had full powers and developed clauses whereby it defined its objects, not subject to any requirement by law, but just a declaration of the companies existence. This was however short lived as emerged the doctrine of ultra vires which followed proceedings in 1720 where the statutory affairs of companies were reversed. This led to the limitation of the powers that companies could have and the powers were limited to only what the company needed either implied or express to carryout to carry out the expressed objects. Lord Slebron in 11 avowed that the memorandum of association of a company also delineated the limitations of the powers of law that the organization had as pertained to the formation of contracts. The doctrine of separate legal entity is also affirmed in Street declaration where he defines a company as a legal person and not as a natural person.12 Consequently, restrictions independent of the ultra vires clause have been developed, explaining the extent of the legal capacity of a company that would operate if it was not a prerequisite for companies to express their object clauses. The English law in its quest to treat companies as separate legal entities refuses to bestow companies with traits of individuals, with reference to their social and human nature. This further denies the companies individual duties and rights which are prevalent in every individual. At law, a company has no mind and has no physical attributes. This restriction is expressly avowed in the case of Continental Tyre & Rubber Co. (G.B.) Ltd v Daimler Co13 where a corporation is defined as an artificial legal person lacking a physical existence. The company is avowed to exist only in law context and is described as lacking passions, body parts, and cannot engage in wars or choose to be loyal or disloyal. Additionally, a company can neither be a friend nor an enemy and other that its corporations, it has no wishes, thoughts or intentions since lacking a mind of its own; it thrives on the minds of its corporations. This was further affirmed by the House of Lords in the same case who avowed that a company is not a natural person and thus lacks a conscience and a mind. Also, Lord Lindley in the case of Citizens Life Assurance Co. v Brown14 ruled that a company has no mind and intentions of its own as it lacks it a natural human nature. These two independent rulings further affirm why groups companies should be treated as separate legal entities: they lack a mind and have no natural person capabilities. Having reviewed the extent of the legal capacity of a company which illustrates that the company is not accorded the same provisions as an individual and is thus a separate legal entity, it is important to review the second principle which explains the nature of the legal capacity. Principle 2: Nature of the Company’s legal capacity Extent of the legal capacity that an organization has stipulates that an organization is a legal structure that is independent of its owners. The nature of the legal capacity of a company illustrates that a company can be a trustee or agent of its managers of members. This means that an organization serves as an independent representative of its members delineating the nature of its legal capacity. This is illustrated when a company engages into a contractual agreement with another company illustrating the independence of the company. However, as earlier stipulated that the company has no mind of its own, this shows that the company in quest to illustrate the nature of its legal capacity, it represents the interests of its members. This is a concept that rather clouds the independence of an organization especially since the organization has no capability of making decisions but thrives on decisions made by its members. Despite this notion, in the case of Lee v Lee’s Air Farming Ltd15 it is not whether or not the company is portraying independence of mind but on whether there is a question as pertains to the rights the organization exercises on its members’ behalf. The nature of a company’s legal capacity can also be explained with reference to subsidiary companies. A subsidiary company is a company where a holding company has more than 40% share capital in another company. This kind of relationship has been evaluated in an attempt to ascertain the independence of the subsidiary company from the holding company. Despite the acknowledgment that subsidiary companies are controlled by holding companies there is no complete control that exists between the two companies. This illuminates that the subsidiary company cannot be termed as being the agent of a holding company and despite being in a group of companies, the English law regards them as two separate entities. This is avowed in the cases of Ebbw Vale U. D. C. v South Wales Traffic Area Licensing Authority16. See also William Cory & Son Ltd. V Dorman Long & Co. Ltd17 and Merchandise Transport Ltd. V British Transport Commission18. Conclusion as pertains to nature of the legal capacity of a company is evidenced in the great case that was used to define the company as a separate legal entity form its owners. This was the decision made by Lord Macnaghten in the case of Salomon v Salomon & Co. Ltd19when he avowed that with reference to law, a company is distinct from the individuals that sign the memorandum. However critics say that the company is the individuals, who make decisions, receive profits or enter into contractual agreements on behalf of the company. However, according to law, the company is distinct and is not in any way an agent to its members or managers thus delineating the nature of legal aspect of a company. The House of Lords avowed that any other perspective of this would be contrary to the English law of companies. It is thus viable to note that the nature of the legal system in a company is that it is a separate legal entity from its shareholders and also from its subsidiary companies. Decided cases reveal that according to the English law, a company does not serve as a trustee of its shareholders or its subsidiary company but it is rather regarded as a single entity in the eyes of law. Having had an insight into the second principle of the nature of legal relationship, analysis of the third principle which reviews the company’s procedural capacity will be explored.20 Principle 3: Company’s procedural capacities A company has not only been defined as a legal entity capable of owning property, but has also been described as being an association of individuals who in the eyes of the law are separate entities. This therefore necessitated the need to review under what circumstance if any the company had the capacity of being relied upon by its members and if the company had separate procedural powers. Two rules were generated in assertion that the company had independent procedural powers since in no way would the members of the company act on behalf of the company, or for the benefit of the company. Consequently, in the formation of contracts with the company, other companies were more concerned with the capability of the company to act within its capacity as an independent entity and not on the capability or the benefit of the company members. The independent procedural capacity of the company was evidenced in the cases of Foss v. Harbottle21 where it was avowed that any contract with the organization was prima facie in the independent capacity of the organization. See also Royal British bank v. Trquand22 where outside parties were to relate with the company as a legal entity and not take into consideration the internal components of the members of the organization. In finality, three principles have been discussed independently in an attempt to illustrate the separate legal aspect of an organization from its shareholders. The first principle illustrated that a company is legally restricted and limited by the company objects and by common law. This limits the company to performance of those activities that are not only lawful but are within the realm of the purpose of the company. The second principle affirmed that organizations are accorded legal capacity to enter into contractual agreements with other organizations. It defines the company as not having the rights accorded to a natural human being and is independent from contractual capacity of members of the company. The third principle outlines that the law gives an organization the right to engage in procedural capacity vis-a-vis its outsiders and members. The icon case ruling as pertains to the treating of companies as single entities is Salmon v Salmon Ltd and it provides the description of a company that illustrates that a company is separate from its shareholders and thus a distinct entity. Having reviewed why companies are treated as separate legal entities according to English law, it would not be wise to assume that there are no critics or loopholes to the separate legal entity clause especially in group companies. With this in mind, the remaining part of the paper will evaluate the reforms needed in the treating of companies within the same group as separate legal entities. A brief introduction as pertains to companies in the same group will also be illustrated. Companies within the Same Group As has been noted, business legal structures are crucial in determining how particular business entities carry out their activities. Companies within the same group tend to carry out their activities in similar ways. Most businesses use group of companies as the medium through which they carry out their activities. Businesses use this medium because it enables them to comply with legal requirements within specific jurisdictions.23 For example, a business may open a new business abroad and conduct it through a subsidiary in order to comply with the legal requirements of those particular countries. Additionally, there may be other advantages that arise as a result of conducting business through group of companies. Tax advantages and reduced risk exposure are the most notable advantages that benefit the parent company in the long- run. Based on Salomon entity concept, English law continues to treat all companies within the same group as separate legal entities, thus implying that these companies are not their controlling shareholders’ agents. It should be noted that companies within the same group are arranged in such a manner that they have separate liabilities for group’s diverse activities. The fundamental principle of Salomon entity concept is that all companies within the same group are separate legal entities and each of them possesses separate legal responsibilities and rights.24 This principle has stirred debates over the years; the debates have been on whether English company law should maintain its policy of treating companies within the same group as distinct legal entities even in the face of obvious economic connection between them. It is argued that increasing economic connection between companies within the same group calls for change of approach regarding policy that governs companies. Strict use of Salomon approach in the English company law may be inappropriate in the modern business world where economic connection between companies within the same group is increasing and becoming inextricably linked. Company law has to be alive to this reality and explore alternative approaches that treat groups in a manner that their responsibilities and rights are attached to the group rather than on the individual companies.25 As noted in the case of Ord v Belhaven Pubs Ltd, the economic connection between companies within the same group implies that they should not be treated as separate legal entities but should be viewed as the whole group.26 Exploration of alternative approaches would enable English company law to reflect the commercial reality in which the companies within the same group trade and raise finances as a group. It is worth pointing out that English company law has steadfastly maintained that companies are separate legal entities. Mostly, courts in England have been ruling that companies within the same group are separate legal entities based on the English company law. For example, even though the trial Judge in Ord v Belhaven Pubs Ltd had ruled that these companies should be viewed as a group, the Court of Appeal over- ruled the ruling. Besides, the Court of Appeal reaffirmed in the case of The Albazero [1977] that it was a long established and unchallenged judicial decision that companies within the same group were separate legal entities possessing separate legal liabilities and rights.27 This case involved Concord Petroleum Corporation that was a wholly owned subsidiary of Occidental Petroleum Corporation. However, in some cases courts have held that companies within the same group should not be treated as separate legal entities. For instance, in the case of DHN Food Distributors Ltd v Tower Hamlets London Borough Council [1976], Lord Denning argued that the corporate veil should be lifted because in real sense companies were a group and should be treated as such.28 He argued that subsidiaries are completely bound to the parent company and should adhere to what the parent company says just like in a partnership. As established in the case of Woolfson v Strathclyde Regional Council, the question of whether the corporate veil should be lifted or not can be well determined by the element of control between the parent company and the subsidiaries.29 Companies within the same group have multiple levels at which the parent company- subsidiary relationship is intertwined. The main question in the Woolfson v Strathclyde Regional Council was whether subsidiaries should be regarded as separate legal entities for legal purposes; should they be regarded as single entity in order to enable them achieve certain legal ends such as claiming compensation?30 This case disapproved the views of Lord Denning and held that they should be treated as separate legal entities for legal purposes. Most subsequent rulings have continued to maintain that companies within the same group should be treated as separate legal entities. The most notable is the case of Adams & Others v Cape Industries Plc [1990] that established that operation of companies as a single economic entity should not be the basis for piercing the corporate veil.31 In this case, it was argued that subsidiaries are one entity for economic purposes and this should not mean that they should be treated as a single entity for legal purposes, because each of them are independent entities. However, the court ruled that the corporate veil can be lifted in exceptional circumstances. The court argued that the fact that a company is controlled by another person does not imply that the separate personality of the company should be ignored. Along with that, the court held that agency argument should be used as a reason to treat companies within the same group as a single entity; establishing agency relationship is difficult unless express agreement is present. The Need for Reform As it can be seen, English company law has steadfastly maintained its policy of treating companies within the same group as distinct legal entities, in spite of the obvious economic connection between them. There is a two-fold argument regarding this aspect of English company law: English company law should maintain its policy of treating such companies as distinct legal entities; and, English company law should reform its policy and treat such companies as a single legal entity.32 The proponents of the first argument argue that treating companies as single economic entity but distinct legal entities produce just results. Conversely, the proponents of the second argument argue that treating such companies as a single entity for legal purposes result to purely technical and unjust outcomes. These arguments have been extensively tested in the English courts and most have them have maintained that such companies should be treated as separate legal entities.33 It is against this background that it is important to consider whether there is need for reform in the English company law or not. In order to consider whether there is need for reform or not, it is crucial to understand the reason why English courts are maintaining that companies within the same group should be treated as separate legal entities. The proponents of this argument are of the opinion that Limited Liability Company is one of the most important discoveries of the present times. Specifically in England, it is credited for allowing investors to pool their resources and diversify risks while at the same time getting the benefit of limited liability. As such, it is credited for allowing wealth of the nation to grow and enterprises to flourish. Since the economic benefits derived through limited liability companies are enormous, courts are reluctant to allow English company law governing the same to be pierced into.34 For instance, it is argued that if the principle of limited liability in the shipping industry is removed, the industry will collapse. In addition, the proponents of this argument argue that if companies within the same group are treated as a single entity they may avoid liability. A good example given for this assertion is that tort victims will find it difficult to attach liability to the shareholders of the parent company. It is in the light of these arguments that most courts feel that it would be illegal for companies within the same group to structure themselves as single economic and legal entities. As noted, the opponents of the argument that companies within the same group should be treated as distinct legal entities argue that such treatment leads to purely technical and unjust outcomes, and therefore, there is need for reforms to the English company law. They argue that reforms would enable companies to be treated not just as a single economic entity but also as single legal entity. This will mean that the liabilities and responsibilities of the subsidiaries will be treated as those of the parent company.35 The English company law can be reformed in a number of ways so as to ensure that, companies within the same group are treated as single entities, legally. One of the ways that this can be achieved is by making the directors of the parent company to be more accountable for the decisions they make. The duties of the parent company director’s should be expanded to include bearing responsibilities and liabilities of the subsidiaries. Their actions should be directed towards ensuring the success of not just the parent company but also the subsidiary companies. Obligations should be imposed on the directors that whenever they are making decisions they should consider the possible consequences in the long term, to the company’s business relationship with customers and suppliers, interests of the employees, and the impact of the company’s and its subsidiary operations in the community and society in general. It is argued that increasing responsibilities and liabilities of the directors, as well as the shareholders’ rights will help reduce the concerns of companies within the same groups.36 As it is now, English company law maintains that companies within the same group should be treated as distinct legal entities. This scenario can be greatly attributed to the already mentioned reasons, the main one being that Limited Liability Company is considered to contribute immensely to economic growth and development in England and therefore the laws governing it should not be pierced.37 Contrary to this opinion, there is an argument that this law is unjust and there is need to reform it. In the light of these arguments, the English company law should continue maintaining that companies within the same group should be treated as distinct legal entities but as a single economic entity. However, there is need for reforms regarding the law governing Limited Liability Company. The reforms should include making the directors more personally accountable for the decision they make. Besides, the reforms should ensure that the actions of the directors are geared towards enhancing the success of the business. Since there have been no notable adverse consequences for treating companies within the same group as distinct legal entities, it cannot be considered wise to overhaul the English company law to enable such companies to be treated as single legal entities. This is because it may have negative consequences to business and the entire economy.38 Conclusion As it can be observed from the discussion, Salomon approach established that companies within the same group should be treated as distinct legal entities. This principle has been upheld for many decades, especially in England. Basing their arguments on the approach, courts have dismissed attempts to consider such companies as single legal entity. The cases in this discussion show that the courts, and actually the English company law, treat companies within the same group as distinct entities; that is, each subsidiary is a distinct legal entity separate from the parent company and other companies. As noted, critics of this approach consider it unjust, and therefore, English company law should be reformed to make such companies a single legal entity under the parent company. However, there seem to be no sufficient case for reforming limited liability in group of companies. Limited Liability is desirable, justifiable, and beneficial not only to the investors but also the economy of the country. Another argument fronted for maintaining English company law is that it will be economically unwise for the parent company to bear the liabilities and responsibilities of its subsidiaries due to the risks that they are exposed to them in unfamiliar territories. BIBLIOGRAPHY A. CASES Adams & Others v Cape Industries Plc [1990] 2 WLR 657 Ashbury Railway Carriage and iron Co. v Riche (1875) L.R. 7 H.L. 653 at p. 694, per Lord Selborne Broderip v Salomon [1895] 2 Ch. 323 at pp. 330, 331, 338, 339, 341, Citizens Life Assurance Co. v Brown [1904] A.C. 423 Continental Tyre & Rubber C. (G.B.) Ltd. V Daimler Co. Ltd [1915] 1 K.B. 893 at p. 916. Daimler Co. Ltd. V Continental Tyre & Rubber Co. (G. B.) Ltd [1916] 2 A.C. 307 at p. 329. DHN Food Distributors Ltd v Tower Hamlets London Borough Council [1976] 1 WLR 852 Gilford Motor Co. Ltd v Horne [1933] Ch. 935 at p. 965. Houghton & Co. v Nothard, Lowe and Wills Ltd [1928] A.C. 1 at p. 14. I.R.C. v Sansom [1921] 2 K.B. 492 at p. 514 (C.A) Lee v Lee’s Air Farming Ltd [1961] A.C. 12 Ord v Belhaven Pubs Ltd [1998] 2 BCLC 447 Salomom v Salomon & Co [1897] A.C. 22 at p. 32 The Albazero [1977] A.C. 774. Woolfson v Strathclyde Regional Council [1978] UKHL 5 B. BOOKS P. Davies, Gower’s Modern Company Law, Sweet and Maxwell, 2008, pp. 76-80. D. Kershaw, Company Law in Context, Oxford: Oxford University Press, 2009, pp. 102-110. L. Sealy and S. Worthington, Cases and Materials in Company law, Oxford: Oxford University Press, 2010, pp. 126-139. W. S. Holdworth, History of English Law, Vol. VIII, pp. 215-217. C. JOURNALS P. Davies & J. Rickford, 'An Introduction to the New UK Companies Act: Part II', European Company & Financial Law Review, 5, 3, 2008, pp. 239-279. M. A. Turner, '"Piercing the Veil" of Limited Liability Enterprises', Strategic Finance, 92, 4, 2010, pp. 51-55, D. WEBSITES The Modern Law Review. Volume 31, Issue 5; 1968: 1-32. Retrieved on March 28, 2012 from Read More