Limited Liability - Essay Example

Business Law corporate personality Explain and evaluate the concept of ‘corporate personality’, considering the attitude of the courts to this important part of company law. The issue in this question refers to an explanation of the doctrine of separate legal entity and the approach the courts have followed in finding for such a corporate personality and the instances where the veil of incorporation has been lifted. An explanation of these key concepts and the attitude of the courts will be discussed in the following paragraphs and the reasons for such an application will follow and finally a conclusion as to the position would be provided. Corporate personality as stated above refers to the existence of a company and due to such existence the right of the company to sue and be sued in its own name, hold its own property and liable to any debts that are accrued(Rose et al 2009). The main provision of this concept is limited liability (that is the liability of the shareholders is restricted only to the unpaid amount of their shares) for shareholders and therefore the debts of the company are restrained to the legal entity of the company. (Ridley 2009) The concept evolved when small businesses began to avail the use of such corporate form and this was done in the landmark decision of Salomon v Salomon1 where Mr. Salomon, a leather merchant formed a company which included his wife, five children and himself (this was done to fulfill the requirement of shareholders as per the Companies Act prevailing at that time). He appointed himself as the managing director of the company and subsequently purchased the sole trading business. However the valuation placed on the business being purchased was not fair, but this was due to his confidence in the business and not due to any mala fide intentions. The business was valued at 39,000 pounds of which 10000 were paid by issuance of debentures plus 20,000 shares at 1 pound each and 9000 pounds in cash. After a certain period the company went into insolvent liquidation and a liquidator was appointed by the court. The liquidator evaluated that the company was a sham and a mere agent of Mr. Salomon and went on to conclude that he should be held personally liable to the debts of the company. The House of Lords reversing the decision of the Court of Appeal, which was a moralistic approach, stated that the fact that some of the shareholders were holding shares so as to fulfill a technicality was irrelevant and so the procedure which had been laid down by the Companies Act could be used by any person who in reality wanted to carry on what was in reality his own business. The Court further went on to state that if a company had been formed in accordance with the Companies Act, it was a separated legal entity and not per se and agent or trustee of the person who controlled it. This was the benchmark case which introduced the concept of separateness of corporate personality from its members and this principle was firmly embedded as a principle of English Law. Critics argue that this principle is well established because of the fact that the case was decided well before the 1966 Practice Statement, which allowed the House of Lords to overturn its own decision(Davies et al 2008). The current Companies Act 2006 (s.7) allows a company to be formed by a single person. The next decision that was made by the House of Lords was Macaura v Northern Assurance Co.2 where a person sold his timber estate to a company formed for the purpose. The insurance of the timber was taken out in his own name. The Defendant that is the insurance company denied the claim of insurance when the timber was destroyed by fire. It was argued that the company was the right person to insure the timber. The court upheld the argument even thought the plaintiff was the only shareholder and the largest creditor of the company. The court went on to say that under corporate personality assets belong to the company (Dignam et al 2010). Otto Khan-Freund states ‘sometimes, as shown by the cases concerning insurable interest “corporate entity’ works like a boomerang and hits the man trying to use it.”3 In Lee v Lee’s Air Farming4 the court found that the person who incorporates a company can enter into a contract of employment between the company and himself. Lord Morris stated that one person could be involved with the company in dual capacitates and a relationship of employment between the company and the person incorporating the company can be created because they were distinct legal entities (Taylor 2009). The main provision of separate personality is limited liability which is logical consequence of such an act. This is a principle under which the shareholder is not held responsible for the debts of the company. There are provisions which allow formation of a company without limited liability, which are known as unlimited company (s.1(1) Companies Act 1985) (Keane 2007). The concept of separate legal entity has been scrutinized by the courts by a process known as lifting the veil of incorporation, whereby the rights and liabilities of a company and the rights and liabilities of the shareholders are treated the same. Thus the concept of limited liability vanishes and the shareholders are held accountable for the acts of the company. This is known as lifting the veil. The court may find the company to be a “sham” or “fraud”. The current position under UK company law is that the veil of incorporation is rarely lifted. There had been various attempts by the Court of Appeal to set up a theory of what is called economic reality and a doctrine under which controls on lifting the veil were placed. The House of Lords on the other hand applied a traditional approach. The case currently being followed is that of Adams v Cape Industries plc where it was said the veil would be lifted only if the company is create with the intent or purpose of fraud or where the reason was for avoidance of an existing obligation. The courts have allowed parent companies not to be held liable to acts of subsidiary if certain facts are found. (Dignam et al 2010) The effect of the principle of Salomon allows individual subsidiaries within a group of companies to be treated as separate legal entities and so parent companies are not held liable for the debts and insolvency of the subsidiary. Lord Denning stated that there were exceptions to the Salomon principle whereby the court would examine the overall operation of business of the economic unit and the veil might be lifted (DHN Food Distributors v Tower Hamlets)5. The concept of a single economic unit looks at the running and separation of important positions within the company and if it is found that the parent is involved in the decision making of the subsidiary or acts as a shadow director the veil may be lifted. The approach of Lord Denning has been applied with caution in later cases (Woolfson v. Strathclyde)6 (Davies et al 2008). The courts went on to reject the ‘single economic unit’ theory in Adams v Cape Industries where it was stated that where there had been rules created to avoid the Salomon principle, they were mere instances of unknowingness of what should be done. The corporat veil can therefore not be lifted just becuse justice requires so. (Trustor v Smallbone (No. 2)7. However the courts have adopted to “equitable discretion” such as mala fide test so as to ascertain the purpose of setting up of the company (Dignam et al 2010). There have been cases where the courts have found that the company had been set up as a “facade” with the intent to defraud creditors of the defendant (Jones v. Lipman)8. In another situation the courts granted injunction where it was found that the person trying to set up the company was due to avoidance of a restraint of trade clause (Gilford Motor Co. Ltd. V Home)9. These exceptions are classified as ‘fraud exception’ (Davies et al 2008). Thus even though the principle of corporate personality has been well established by the courts, the concurrent application of lifting the veil had created a bit of uncertainty, which has been to a very great extent been resolved and the courts have identified a number of situations under which the veil of incorporation would be lifted. The single economic unit and its rejection has been criticised because they often times tend to allow for parents to get away but if seen on the cases there has been a balanced approach to such actions whereby the courts have preserved the doctrine of separate legal entity and upheld the rule of law. Therefore the current approach of the courts towards corporate personality and lifting the veil is a justified approach. References: DIGNAM, A. J., & LOWRY, J. P. (2010). Company law. Oxford, Oxford University Press DAVIES, P. L., & GOWER, L. C. B. (2008). Gower & Davies: the principles of modern company law. London, Sweet & Maxwell ROSE, F. D., & ROSE, F. D. (2009). Company law. London, Sweet & Maxwell KEANE, R., & KEANE, R. (2007). Company law. Haywards Heath, West Sussex, Tottel Pub TAYLOR, C. (2009). Company law. Harlow, Essex, England, Pearson Longman. RIDLEY, A. (2009). Company law. London, Hodder Education. Read More