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Published: Fri, 02 Feb 2018

Analysis of the incorporation of a business

A company comes into existence is generally by a process referred to as incorporation. Once a company has been legally incorporated, it becomes a distinct entity from those who invest their capital and labour to run the company, (Robert R Pennington, 2001). The corporate company is an ‘artificial person’ who has separate legal personality. In an corporate company, even though companies are formed by members, the members are not individually directly liable to its creditors for debts owing by the company. The leading case Salomon v Salomon & Co Ltd(1897) AC 22 established the principle of separate legal personality by House of Lords. Where one man owned however large proportion of shares and debentures in a company, or even if he hold other shares in trust for him, neither the company’s acts not its liabilities are this person’s acts or liabilies. The ‘veil of incorporation’, protecting members from liability for company debts, and highlighting that companies as a separate entity are distinct from members in the company. However, the ‘advantages’ of corporate personality may be used by some fraudulent and unscrupulous people for the purpose of committing fraud, or as a means to evade a contractual or other legal obligation, Thus, in some certain cases, the courts will lift ‘the veil of incorporation’. In this essay, I would look through the formation of company and concentrate on how promoters’ relationship with company and what are promoters’ duties. the concept of corporate personality based on Salomon & Salomon, and the consequences of lifting the veil of incorporation.

Usually the first step to form a company is the process known as ‘promotion’ where a person persuades others to contribute capital to a proposed company before it is incorporated . Such a person is called the promoter of the company (Josephine R. Bisacre, 1992). Promoters also can enter into a contract on behalf of a company before or after it has been granted a certificate of incorporation, and arrange share issues in the name of the company.”Promoter” is not defined in the Companies Act. The definitions of promoter have been developed through the courts. The case law indicates that as a promoter of a company, it is essential to show that the person concern to contribute some essential elements to the incorporate company. For instance, organising the appointment of a company director. In case Whaley Bridge Calico Printing Co V Green(1897) 5 QBD 109, Lord Bowen J gave the opinion on whether a person could be a promoter or not, said:“ The term promoter is not a term of law but one of business, usually summing up in a single word a number of business operations familiar to the commercial world.”( Stphen Griffin, 1996) However, a person who is merely acting in a professional skill ,for example, an accountant is not a promoter.

The duties of promoters (are not contained in statue) have been developed through case law that promoters must excise reasonable care and skill in their performance of running business. A promoter is a fiduciary of the company he promotes and as such he owes fiduciary duties towards it. As a consequence of the promoter’s fiduciary duties (duties of loyalty an good faith), promoters must make full disclose of any personal interest in a company contract, for instance, not to make a secret profit from their duties without company’s consent, they must account for any profits made. (case Gluckstein v Barnes). Moreover, a company may sue its promoter for damages for breach of fiduciary duty. Furthermore, promoter may commit a criminal offence if they defraud the Company by deliberately, for example, make misleading statement of any affairs relating to the company. Other duties of promoters, such as: not to disclose confidential information to outsiders and not to hide his personal interests through a nominee are also important.

In my opinion, I agree on that Lord MacNaughten’s statement on “those people whose motives in setting up a company are absolutely irrelevant in determining corporate liability.”Ultimately, promotion is concerned with taking essential steps in formation of company, without promoters, companies are not possible set up. Promoter is personally liable on the contract (the pre-incorporation contracts) until corporation is formed and adopts the contract, and is not relieved, until substitution occurs. Promoter is not personally liable on the contract but is liable if failed to take steps to incorporation. Promoter is not personally liable but view transaction as a revocable offer that is binding only after corporation is formed and adopts the contract. The duties on promoters protect the investors from any fraudulent attempt on promoters to obtain undeclared profits.

In Salomon v. Salmon & Co.Ltd case, House of Lords held that once the company has been incorporated as an entirely separate legal person from Salmon himself, therefore, Salomon did not have liability to indemnify to creditors’ claims to this company. The key point in this case is that the Salomon’s company had been incorporated properly as the issue of its certificate of incorporation. That is why Salomon was under no liability to the company and the court could not hold the incorporation void. In the words of Lord Lindley LJ(1897):“The liability does not arise simply from that he holds nearly all the shares of the company…his liability rests on the purpose for which he formed the, on the way he formed it, and the use which he made of it.” (Robert R Pennington, 2001).

Because an incorporated company is a “person” who distinct from its member, it enjoys separate legal personality (or corporate personality). A company has perpetual succession, accordingly to this that members may come and go but the company could theoretically live forever. Company can own and deal with property by itself not by members, sue and be sued in its own name and contract on its own behalf. Besides, company has won contractual rights and duties, thus, company signs contracts in its own name and arising benefits belong to the company directly not to the members. Also, companies may be liable in tort. In case Foss v Harbottle (1843) 2 Hare 461, two shareholders brought an action against directors for suffering a loss by a company under director’s fraud. The court held that the company could sue if it wished but individual members were not allowed to sue in case like that. Moreover, membership enjoys limited liability, he/she is not personally entitled to cover company’s debts ( limited companies only). Other effects of corporate personality such as , companies are easier attract more loans to finance than partnership , companies have unlimited capacity for growth. A small company can become a large conglomerate. In corporate companies, corporation tax applies and Shareholders and directors pay income tax on in respect of their dividends. While partners are subject to income tax and capital gains profit on their trading profit. It is clearly to see that the larger the scale of business enterprise the more tax advantages will be in the corporate form.

According to British law, corporations are shielded from the liabilities of their subsidiaries by the ‘corporate veil’. It was well established that a corporation is an artificial legal person with a ‘corporate personality’. Notwithstanding the principle of Salmon case indicated that company had corporate personality, there are some certain situations where the ‘veil of incorporation’ can be lifted by the courts. The following circumstances are when members/subscribers are personally liable for things they do in the name of the company

First of all, the veil would be lifted where a company was set under the purpose of committing fraud. In Trustor AB v Smallbone (No.2) [2001] 1 WLR 1177, a company was used to commit fraud, it was held that the owner of this company was personally liable to refund the debts to the claimant.

Secondly, the corporate structure cannot be used as a means to avoid legal or contractual responsibility. In case Jones v Lipam [1962] 1 All ER 442, the defendant (L) supposed to sell a land to claimant (J) under a contract, however, L sold the land to another person. L formed a new company and transferred the land to it. Held that the L’s new company was a sham obligation, the L and his ‘old’ company were bound to perform the contract with J. If there is an attempt to use corporate structure to undermine the provisions of the law, the veil could be lifted, too.

Another circumstance for lifting the veil of incorporation, is when companies in a group are not treated as a single economic entity, this would only happen when the group structure was a sham or use to commit a fraud. Under Company Act 2006, group of companies filling one account would lift the veil as well as companies in a group are required to produce a group account.

Furthermore, directors are personally liable when they commit a wrongful or fraudulent acts during their company’s insolvency, or directors would be jointly liable with the company while director continuing to act disqualified.

Sometimes the veil also be lifted simply by the public interest or national emergency. Finally, a court may lift veil just because that it is equitable to wind up.

The main classifications of incorporated companies are: limited and unlimited companies or public companies and private companies-Company Act 2006. Whilst an unlimited company is a legal entity where members have unlimited liable for their company debts, a limited company allows members to contribute to his debts on liquidation is limited. There are two types of limited company, one is a company limited by shares where the liability of the members is limited to any amount yet unpaid on the shares. Or a company limited by guarantee which requires each member to contribute a specified sum towards payment of the company’s debts. In relation to a shareholder of a limited liability UK company limited by shares, in normal circumstances, shareholder pay the amount has agreed to pay for the shares in the company. For example, if the shareholder also being a director of the limited liability Company, and give personally guarantee of the limited company’s debts or obligations, they will be personally liable when they commit a wrongful or fraudulent acts during their company’s insolvency

In summarise, the legal separate personality of an incorporate company is largely a doctrine of case law, the principle of Salomom v. Salomon clearly established a separate legal personality of company. The law relating to promoter’s duties and liabilities with the relationship of company is mostly developed through case law. Although promoters are personally liable to the company before the company incorporate (pre-incorporation),their motives in setting up a company are absolutely irrelevant in determining corporate liability. The corporate personality protects individual members from paying limited liability on companies’ act. From the factor that companies are artificial persons that therefore need someone to direct and run it. People behind the veil of incorporation may use company as a means to commit fraud. In order to deal with that problem, court established another principle called“ lifting the veil of incorporate’ where has been enunciate in Jones v. Lipman which was mentioned before in this assignment.

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