Corporate Personality and Limited Liability

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 above-mentioned 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 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.

http://encyclopedia2.thefreedictionary.com/ Corporate+person

corporation, in law, organization enjoying legal personality for the purpose of carrying on certain activities. Most corporations are businesses for profit; they are usually organized by three or more subscribers who raise capital for the corporate activities by selling shares of stock stock, in finance, instrument certifying to shares in the ownership of a corporation. Bonds are similar evidences of shares in a loan to a corporation. Stock yields no dividends until claims of bondholders have been met.

….. Click the link for more information. , which represent ownership and are transferable. Besides business corporations, there are also charitable, cooperative, municipal, and religious corporations, all with distinctive features. In the United States all governmental units smaller than a state (e.g., counties, cities) are municipal corporations. Certain religious functionaries (e.g., Roman Catholic archbishops) legally are corporations sole.

The legal personality of a corporation is symbolized by its seal and its distinctive name. As a legal person, the corporation continues in existence when the organizers lose their connection with it. In most cases its liability is limited to the assets it possesses and creditors may not seize property of persons associated with the corporation as stockholders or otherwise. Legal personality gives the corporation many of the capacities of a natural person; e.g., it can hold property and can even commit crimes (for which it may be fined and its directors imprisoned).

The Modern Corporation

The modern concept of corporate power holds that the rights of the participants as well as the conduct of the enterprise must be the subject of managerial discretion. The salient characteristic of the modern corporation is the separation of management from ownership. Management of industrial corporations now requires executive managers and a corporate bureacracy to oversee its complex and interlacing activities.

The large business corporation has strongly influenced the control of property in the modern world. The large corporations are typically controlled by a small minority of the stockholders. There are several methods employed by small groups of stockholders to gain control of large corporations. These include pooling of the majority of stock in the hands of trustees having the power to vote it and the use of proxies (agents for the actual stockholders pledged to vote for particular candidates for managerial positions). Proxies are generally successfully used because stockholders rarely attend meetings or name proxies other than those suggested to them by management.

A more recent type of corporation is the holding company, organized to buy a controlling interest in other corporations; this type of corporation typically possesses no physical assets. The amount of cash needed to control a concern is lessened by pyramiding holding companies. This is done by creating a company to hold a voting control of one or more operating companies. A third company is created to hold a controlling interest in the second, and so on. The control of the last holding company is sufficient to control all; and such control, because of the scattering of stock among many small holders, may need the ownership of only 10% or 20% of the stock available.

See also trust trust, in law, arrangement whereby property legally owned by one person is administered for the benefit of another. Three parties are ordinarily needed for the relation to arise: the settlor, who bequeaths or deeds the property for another’s benefit; the trustee, in

….. Click the link for more information. .

The Regulation of Corporations

Until 1844 incorporation in England continued to be a matter of special grant by the king or Parliament. New corporations were created in the Industrial Revolution to finance larger economic units, such as railways and steam-driven machinery in factories. In the United States the state legislatures became the chief authorities to grant charters to corporations, although the federal government incorporates in a limited field. Federal charters were granted to both of the Banks of the United States, to certain railroads after the Civil War, and to the Communications Satellite Corporation (Comsat). Corporations owned by the federal government and financed by government appropriations include the Federal Deposit Insurance Corporation, the Community Credit Corporation, and various corporations established to meet emergencies and later liquidated. At first states passed a special act for each incorporation, but in 1811, New York state enacted a general incorporation law enabling the secretary of state to give charters. Since the Dartmouth College Case Dartmouth College Case, decided by the U.S. Supreme Court in 1819. The legislature of New Hampshire, in 1816, without the consent of the college trustees, amended the charter of 1769 to make Dartmouth College public. The trustees brought suit.

….. Click the link for more information.  of 1819, when a charter was held to be a binding contract between a state and a corporation, unalterable and unamendable by the state without the corporation’s consent, fewer perpetual charters have been granted, the right of the legislature to alter or annul being specifically reserved in the charter. Variability in state incorporation laws and the ability of corporations incorporated in one state to do business in all other states have allowed corporations to incorporate in the state or states having the most lenient incorporation laws. In general, the history of corporations in the United States has been marked by the abdication of state control over corporations.