Separate Legal Personality of the Company

Incorporation by registration was introduced in 1844 and the doctrine of Limited liability followed in1855. Subsequently, in 1897 in Salomon v Salomon And Company [1] , the House of Lords explored the effects of these enactments and cemented into English Law the twin concepts of corporate entity and limited liability. Incorporation gives the company legal personality which distinct it from its members and with this right, the Company may own property, sue and be sued in its own corporate name. It has perpetual succession i.e. It will not die when its members die. There are many areas in the company law where the legal rules are shaped by and to the some extent flow from the concept of separate personality. Thus, the share capital, once subscribed must be maintained by the Company, it no longer belongs to the members and cannot be returned to them except subject to stringent safeguards. The rule that for a wrong done to the company, the proper claimant is the company itself is similarly largely the result of this principle. The ‘separate personality’ concept is often spoken of as though it also necessarily involves the idea that the liability of the company’s members is limited but of course this is not always so, it is perfectly possible to form an unlimited Company u/s 3(4) of the Companies Act, 2006. It has no limited liability, but under the corporate entity doctrine it will have separate legal personality. In practice, most companies are limited companies. Corporate personality and limited liability tend to go hand in hand [2] .

The corporate entity principle was firmly settled at the end of the 19th century in the Salomon case. In this case, Mr. Salomon was a wealthy man in 1892. He was a boot and shoe manufacturer trading on his own sole account under the firm name ‘A Salomon & Co’. He had been in the trade over thirty years and did not want to leave the business. He had his wife, four sons and a daughter working with him. His sons kept pressing him to give them a share in the business so he turned his business into a limited company. He wanted to extend his business and make provision for his family. All the requirements of the Companies Act, 1862 were duly observed. Section 6 of the Companies Act, 1862 provided that seven or more persons together could incorporate a business, provided that it was associated for a lawful purpose. There was a contract with a trustee in the usual form for the sale of the business to a company about to be formed. There was a memorandum of association duly signed and registered, stating that the Company was formed to carry that contract into effect, and fixing the capital of £40,000 in 40,000 shares of £1 each. The subscribers to the memorandum were Mr. Salomon, his wife and his five children. The subscribers met and appointed Mr. Salomon and his two elder sons directors. The directors then proceeded to carry out the proposed transfer. By an agreement dated 2 August 1892 the company adopted the preliminary contract, and in accordance with it the business was taken over by the company as from 1 June 1892. The price fixed by the contract was duly paid. The Company, A Salomon & Co, purchased Mr. Salomon’s business in a solvent state for a consideration to a value of £39,000. Mr. Salomon received £20,000 and then immediately returned to the company in exchange for fully paid shares. The sum of £10,000 was paid in debentures. Mr. Salomon seems to have received and retained the balance about £1000 went in discharge of the debts and liabilities of the business at the time of the transfer which were entirely thus wiped off. As a result, Mr. Salomon received about £1000 in cash for his business, £10,000 in debentures [3] and half the nominal capital of the company in fully paid shares. No other shares were issued except the seven shares taken by the subscribers to the memorandum. But soon after Mr. Salomon incorporated his business, there was economic trouble. Strikes in the shoe industry led the government. His warehouse was full of unsold stock. He and his wife lent the company money. He cancelled is debentures but the company needed more money. They sought £5000 from Edmund Broderip and gave him a debenture, the loan with 10% interest and secured by a floating charge. The business still failed and they could not keep up with the interest payments. Mr. Broderip took the proceedings at once and got a receiver appointed. Liquidation took place and there was forced sale of company’s assets. Its enough to pay Mr. Broderip but not enough to pay the debentures in full and the unsecured creditors left unpaid. [4]

Looking at the state of things, the liquidator met Mr. Broderip’s claim by a counter- claim to which he made Mr. Salomon a defendant. He disputed the validity of the debentures on the ground of fraud and on the same ground; he claimed rescission of the agreement for the transfer of the business, cancellation of the debentures and repayment of the balance of the purchase money by Mr. Salomon. In the alternative, he claimed payment of £20,000 on Mr. Salomon’s shares, alleging that nothing had been paid on them.

In Broderip v Salomon [5] , Vaughan Williams J. admitted the validity of Mr. Broderip claim and that the 20,000 shares were fully paid up was not disputed. The case presented by the liquidator broke down completely but the learned Judge that the company had a right to indemnity against Mr. Salomon and the signatories of the memorandum of association were mere dummies. Whilst admitting that the company was a legal entity and distinct from its members, the learned Judge was of the opinion that the company was no more than an agent of its principal (Mr. Salomon). As such, the principal was responsible for the debts of its agent. The basis for the agency argument was that the company was a mere alias of its founder and had not been formed in accordance with the true spirit of the Companies Act, 1862. The liquidator counter- claimed that the company was entitled to be reimbursed by Salomon [6] . Company was merely an agent of Salomon and as principal; he was liable for its debts [7] .

The Court of Appeal upheld the decision in the Broderip v Salomon. In his Judgment, Lindley L. J. recognised the importance of the appeal given the increasing number of one-man companies but insisted that an attempt had been made ‘’to use the machinery of the Companies Act, 1862 for a purpose for which it was never intended.’’ Parliament had never considered an extension of limited liability to sole traders or to less than seven. Admittedly, there were seven members in the present case, but ‘’it is manifest that six of them are members simply in order to enable the seventh himself to carry on business with limited liability’’. “The object of the whole arrangement”, he said, “is to do the very thing which the legislature intended not to be done”. It was a corporation “created for an illegitimate purpose”, “to attain a result not permitted by law”. He was also of the view that the relationship between Salomon and the Company was not that of principal and agent but that of trustee and cestui que trust [8] and the creditors could not sue Salomon directly but had to reach him through the company. The decision, he asserted, would leave many small companies “quite unaffected”, but “there may possibly be some companies which, like this, are mere devices to enable a man to carry on trade with limited liability, to incur debts in the name of a registered company, and to sweep off the company’s assets by means of debentures, which he has caused to be issued to himself in order to defeat the claims of those who have been incautious enough to trade with the company without perceiving the trap which he has laid for them”. [9] Lindley LJ held that the Company was a trustee for Mr. Salomon, and as such was bound to indemnify the Company’s debts. Lopes L.J. and Kay L.J. variously described the Company as a myth and a fiction and said that the incorporation of the business by Mr. Salomon had been a mere scheme to enable him to carry on as before but with limited liability. The implications of the Court of Appeal decision for one-man and other private companies were much more serious than those of the lower court verdict. [10]

Lopes LJ also noted that ‘it would be lamentable if a scheme such as this could not be defeated’ [11] .

Vaughan Williams J. and a strong Court of Appeal held that the whole transaction was contrary to the true intent of the Companies Act and that the Company was a mere sham, and an alias, agent, trustee or nominee for Salomon who remained the real proprietor of the business. As such he was liable to indemnify the company against its trading debts. But the House of Lords unanimously reversed this decision. They held that the Company has been validly formed since the Act merely required seven members holding at least one share each. It said nothing about their being independent or that they should take a substantial interest in the undertaking, or that they should have a mind and will of their own, or that there should be anything like a balance of power in the constitution of the company [12] . Hence the business belonged to the company and not to Salomon, and Salomon was its agent. In the blunt words of Lord Halsbury L.C.: [13]

“Either the limited company was a legal entity or it was not. If it was, the business belonged to it and not to Mr. Salomon. If it was not, there was no person and no thing to be an agent at all; and it is impossible to say at the same time that there is a company and there is not.”

Or, as Lord Macnaghten put it: [14]

“The company is at law a different person altogether from the subscribers….; and, though it may be that after incorporation the business is precisely the same as it was before, and the same persons are managers, and the same hands receive the profits, the company is not in law the agent of the subscribers or trustee for them. Nor are the subscribers, as members, liable in any shape or form, except to the extent and in the manner provided by the Act.” [15]

For ‘one man companies’, Lord Macnaghten said that if that was intended to convey that a company under the absolute control of one person was not a legally incorporated company, it was inaccurate and misleading [16] . Likewise, Lord Halsbury emphasised that the sole guide to matters was the statute which did not enact requirements as to the extent or degree of interests which may be held by the subscribers to the memorandum of association [17] . The House of Lords had little sympathy for the unsecured creditors who had only themselves to blame, having had full notice that they were no longer dealing with an individual [18] .

Lord Herschell was of the view,

“It is to be observed that both courts treated the company as a legal entity distinct from Salomon and the members who composed it, and therefore as a validly constituted corporation….Under the circumstances I am at a loss to understand what is meant by saying that A Salomon & Co Ltd is but an alias for A Salomon.” [19]

Lord Halsbury remarked,

“Once the company is legally incorporated it must be treated like any other independent person with 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.” [20]

The Salomon case established that the Company will be validly incorporated if it complied with the provisions of the Act, even it is only a “one person” company and the courts will be reluctant to treat a shareholder as personally liable for the debts of the company by “piercing the corporate veil”. [21]

The objection of the unsecured creditors in this case was based on the overvaluation of the business which was sold to the company in exchange for shares and debentures in it. In the case of modern public company, the business would be the subject of an independent valuation so far as it was used to pay up shares, [22] but in the case of a private company, and even that of debentures issued by a public company, the main protection of unsecured creditors lies in disclosure of the company’s financial position [23] . The unsecured creditors could hope for is that a floating charge securing a debenture might be invalidated if there was a successful petition for a winding-up or an administration order within two years of the creation of the charge [24] . Thus, Salomon was able to give himself protection against the downside risks of his business by taking a position as secured creditor through the debentures, whilst taking the full benefit of any upside gains through his one hundred percent shareholding [25] . This decision does not mean that a promoter can with impunity defraud the company which he forms or swindle his existing creditors. In the Salomon case it was argued that the company was entitled to rescind in view of the wilful overvaluation of the business sold to it. But the House of Lords held that in fact there was no fraud at all since the shareholders were fully conversant with what was being done. The position would have been different if the Salomon made a profit and concealed from his fellow shareholders. There was no fraud on Salomon’s pre-incorporation creditors, all of whom were paid off in full out of the purchase price. Otherwise, they or Salomon’s trustee in bankruptcy might have been entitled to upset the sale [26] .

The House of Lords decision in Salomon has been criticised as going too far. The Contemporary comment of the Law Quarterly Review [27] was that the House of Lords had recognised that one trader and six dummies would suffice and that the statutory conditions were mere machinery. ‘You touch the requisite button and the company starts into existence, a legal entity, an independent persona.’ The decision recognised that the one-man company fell within the policy of the Act. Once limited liability was recognised the creditors must look at the capital i.e. the limited fund and that only. Nevertheless, from the point of view of statutory construction it was thought that such a decision would have been impossible 20 or 30 years earlier. The reference in the Act to the persons being ‘associated’ would then have predicated a partnership. A more drastic modern criticism was that of Professor O. Kahn Freund [28] who described the decision as ‘calamitious’. The Courts, while developing fiduciary principles to protect shareholders, had failed to mitigate ‘the rigidities of the ‘folkfore’ of corporate entity in favour of the legitimate interests of the company’s creditors’ [29] .

Since the Salomon case, the complete separation of the company and its members has never been doubted. The decision opened up new ways to company lawyers and the world of commerce.

There are more illustrations of the incidents of corporate personality which asserts the legal personality of the company such as in the Northern Irish case of Macaura v Northern Assurance Co Ltd [30] Macaura was the controlling shareholder of a company and effected fire insurance in his own name in respect of the property of the company. The question in issue was whether he had an insurable interest in the property of the company. The House of Lords held that only the company had an insurable interest in the property. Macaura had no insurable interest and, therefore, could not claim on the policies. This seems a rather harsh application of the principle although it may be that the House was influenced by the charges of fraud which had been unsuccessful in the earlier arbitration. There seems to have been less than a month between the taking out of one of the policies and the fire. The converse also applies [31] .

A more humane application of the principle which really pushes it to its logical extreme is Lee v Lee’s Air Farming Ltd [32] . This was a New Zealand appeal to the Privy Council. Lee was the controlling shareholder, sole governing director and chief pilot of the company. A governing director has all the powers of management vested in him. Lee died as a result of an air crash while top dressing. The question was whether he was an employee of the company for the purpose of the workmen’s compensation legislation. The New Zealand Court of Appeal had held that he was not; as he was not sufficiently separate from the company. The Privy Council overruled this, applying a strict application of the Salomon principle. The company and Lee were separate legal persons and it was possible for a controlling shareholder and governing director to have a contract with his company which could be the basis of a claim [33] .

Consequences of separate corporate personality [34]

The body corporate has the following consequences:-

An incorporated company never dies. It is an entity with perpetual succession. The death or insolvency of individual members does not, in any way, affect the corporate existence of the company. Members may come and go but the company can go on forever [35] .

Corporate body owns its own property. The assets of a company do not belong to the shareholders. They have only interest through medium of their shares. They have no proprietary rights to the underlying assets. Similarly creditors of the company are not creditors of the shareholders. The creditors must go against the company and it is only if the company is being wound up and there is some evidence of fraud that they may possibly have recourse against the shareholders.

As a separate legal entity, the company can sue or be sued in its own name.

A Company can create a floating charge. This is a type of equitable security which can only be granted by companies and others who are empowered under specific legislation. The essence of a floating charge is that it floats over the undertaking or class of assets until an event occurs which causes it to crystallise, whereupon it becomes a fixed equitable charge. Until then the company can dispose of its assets in the ordinary course of business.

In limited companies, liability of the members is limited. Members are only liable for the amount unpaid on nominal value of their shares. In the case of a company limited by guarantee they are only liable for the amount of their guarantee.

Once the Company becomes legal personality, the company must comply with the formalities of the Companies Acts. This requires payment of the registration fee, and the regular filing of documents and accounts with the Registrar of Companies etc.

Group of Companies

The Courts have sometimes shown a willingness to look upon a group of companies as one economic unit. In Littlewoods Mail Order Stores Ltd v McGregor [36] , Lord Denning stated that the doctrine lay down in Salomon case had to be carefully watched. The courts can and often do draw aside the veil and look at what really lies behind. Parliament had shown the way: the courts should follow suit. A similar line was taken in DHN Food Distributors Ltd v London Borough of Tower Hamlets [37] .

From the decision of the Court of Appeal in DHN Ltd case, it has been said, “but a short step” to “the proposition that the courts may disregard Salomon’s case whenever it is just and equitable to do so” [38] .

D.H.N. Food Distributors Ltd. carried on business as grocery and provision merchants. The premises from which the company traded were owned b a wholly owned subsidiary of the company, Bronze Investments Ltd., and the vehicles used in the business were owned by another wholly owned subsidiary, D.H.N. Food Transport Ltd. The business premises of D.H.N. Food Distributors having been compulsorily acquired by Tower Hamlets London Borough Council, and no suitable alternative premises being available, the company and its two subsidiaries went into voluntary liquidation [39] .

Had the business, the business premises and the vehicles used in the business been in the one ownership, compensation would have been payable, under rules (2) and (6) of section 5 of the Land Compensation Act, 1961 [40] . In the circumstances, however, the acquiring authority paid compensation for the value of the land to the registered proprietors, Bronze Investments, but contended that no compensation for disturbance was payable since Bronze Investments had carried on no business, the business which had been distributed being the business of D.H.N. Food Distributors, which company having no interest in the land, had no claim under the Land Compensation Act.

This contention succeeded before the Lands Tribunal but found no favour with the Court of Appeal, which held that the case was one in which the court was “entitled to look at the realities of the situation and to pierce the corporate veil” [41] ; that the three companies “should, for present purposes, be treated as one” [42] , as “a single entity” [43] ; and that, “ as a group”, the three companies were “entitled to compensation not only for the value of the land, but also compensation for disturbance” [44] .

The decision of the Australian High Court in Industrial Equity Ltd. v Blackburn [45] is hardly consistent with the assertion of a “general tendency to ignore the separate legal entities of various companies within a group”. [46]

The DHN case was not followed by the House of Lords in the Scottish appeal of Woolfson v Strathclyde Regional Council [47] . A similar approach again more consistent with Salomon’s case was taken by the New Zealand Court of Appeal in the case of Re Securitibank Ltd (No 2) [48] .

Further doubt is cast on D.H.N. Ltd. by the case of Multinational v Multinational Services [49] .

Like Woolfson v Strathclyde Regional Council, Multinational v Multinational Services can be distinguished on its facts from DHN Ltd case. However, the tenor of the judgments in Woolfson, Multinational and Industrial Equity Ltd. cases indicates unmistakably that the decision of the Court of Appeal in DHN Ltd case was an aberration and that the principle that “each company in a group of companies……….is a separate legal entity possessed of separate legal rights and liabilities” is “now unchallengeable by judicial decision” [50] .

In Woolfson case, Lord Keith referring with approval to a passage in the judgment of Ormerod L.J. in Tunstall v Steigmann, stated that the corporate veil might be lifted only where the company was a mere “facade” but didn’t explain the term. That the corporator has “complete control of the company” is not enough to constitute the company a mere facade, rather that term suggests, here it means the deliberate concealment of the identity and activities of the corporators. The term is used by the court when lifting the veil in Re Darby, Ex parte Broughman [51] , Gilford Motor Company Ltd. v Horne [52] and Jones v Lipman [53] , all cases in which the company was formed in order to enable the corporators to do through, and under cover of the company what he might not do openly and in person. But whatever be the meaning of term “facade” in this context, the House of Lords has plainly refused to approve any contention that the court may “disregard Salomon’s case whenever it is just and equitable to do so” [54] . The separate legal personality of a company, although a “technical point” [55] , is “no matter of form, it is a matter of substance and reality” [56] and the corporators ought not, on every occasion, to be relieved of the disadvantageous consequences of an arrangement voluntarily entered into by the corporators for reasons considered by the corporators to be of advantage to him [57] . “The ‘group enterprise’ concept must obviously be carefully limited so that companies who seek the advantages of separate corporate personality must generally accept the corresponding burdens and limitations” [58] .

In Trustor AB v Smallbone and others (No3) [59] the managing director of Trustor had transferred money to Introcom, a company which he controlled, and one of the issues which arose was whether the corporate veil of Introcom could be pierced so as to treat receipt by Introcom as receipt by him. Morritt V-C held that the court would be ‘entitled to pierce the corporate veil and recognise the receipt by a company as that of the individual(s) in control of it if the company was used as a device or facade to conceal the true facts thereby avoiding or concealing any liability of those individual (s) and it was satisfied on the facts [60] .

Agency

The Salomon case held that a company was not the agent of its shareholders. It did not exclude the possibility of there being an agent relationship in fact. Occasionally the courts have seemed willing to construe an express or implied agency of the company for its members. The authorities were reviewed by Atkinson J in Smith, Stone & Knight Ltd v Birmingham Corp