This essay has been submitted by a law student. This is not an example of the work written by our professional essay writers.
Published: Fri, 02 Feb 2018
The Acts is an artificial legal entity separate
In the eyes of the law ‘a company registered under the Acts is an artificial legal entity separate and distinct from the members of which it is composed’ (Keane, 1991, p. 103). This is a long-standing and central doctrine of company law which has its origins in the case of Saloman v. Saloman & Co Ltd (1897) in which Saloman, a sole trader, sold his business to a newly formed company, Saloman & Co Ltd in return for 99% of the shares and a debenture of ‘10,000 with his wife and five children owning 1 share each. The company subsequently failed and Mr Saloman sought to be paid before other creditors due to the secured debenture. His claim was contested and eventually the House of Lords ruled that once a company is registered it becomes a distinct legal entity thus separate from the individual entitling Mr Saloman to be repaid the debt owed to him by the company.
Another example where the ruling in Saloman’s case was applied is in Lee v. Lee’s Air Farming (1961). Here Mr Lee incorporated his crop spraying business and later died in a flying accident. His widow sought compensation from the state on the grounds that he was a worker under law while the state argued that Mr Lee was not an employee of the company and therefore not covered by the legislation. The courts held that ‘since the pilot and the company were separate legal entities, they were capable in law of entering into a contract of service’ (Keane, 1991, p. 104) and upheld his widow’s claim.
The idea of separate legal identity is now ‘firmly established’ (Barber, 1981, p. 371) however there are various statutory requirements when incorporating a company and when they have all been complied with, the principle set down in Saloman v. Saloman & Co Ltd provides a ‘veil of incorporation’. In essence, while third parties can identify who the major shareholders in a company are, how many shares they hold and indeed who the key company members are, the veil distinguishes the company from its members. The incorporated company is controlled and directed in its operation by individuals, it may borrow and hold assets in the company name without any of the shareholders or key parties being held personally liable in the event of liquidation; should a third party wish to take legal action,
they must do so against the company. Realistically, and especially in large scale corporations, no individual would willingly take on the full management responsibility of running the firm. It therefore follows that no individual could accept full financial liability for its obligations.
This may sound all-encompassing and it seems clear that the courts feel that should they make shareholders or directors liable for the debts of a company, this could discourage commercial enterprise. Additionally, creditors should be fully aware of the risks they are taking by entering into an agreement with a company as the company’s memorandum is a public document explicitly stating it is limited by shares.
However since Saloman v. Saloman & Co Ltd, the principle has been applied in many other courts and has therefore been subject to examination and subsequent legislation in order to prevent the protection of limited liability being abused. Any modifications to the ruling have been described as ‘occasions on which the veil of corporate personality is lifted’ (Keane, 1991, p. 108) and can result in shareholders and directors being held personally responsible for obligations that would normally rest with the company. Although it has proved difficult to extract general rules, three main reasons why the veil may be lifted are:
? To enforce the provisions of the Companies Acts,
? To avoid fraud, and
? To deal with a group of companies.
There are two ways in which the corporate veil can be lifted; through legislature and by the courts.
In the case of legislature, there are several examples of statutory provisions which have the effect of ignoring the differentiation between the company and its members. For example, should a company’s membership fall below the legal minimum and remain so for more than six months, individuals who knew of the deficit and yet allowed operations to continue, can be held liable for the debts of the company incurred during that period. Similarly, where fraudulent or reckless trading occurs or if a tax offence is committed by a company, should individuals within the company be party to these actions, they can be held personally liable and be subject to legal proceedings.
The Insolvency Act 1986 prevents the creation of ‘Phoenix Companies’ as it is an offence ‘for anyone who was a director of [an] insolvent company during the 12 months before liquidation to be associated with a company with the same name as the insolvent company or a name so similar as to suggest an association’ (Ohrenstein, no date, p. 4). If an individual acts to the contrary, he can be held liable for the debts of the company.
Whilst legislature has ‘modified the consequences of Saloman’s case in clear and unequivocal language’ (Keane, 1991, p. 110), instances exist of the courts lifting the veil of incorporation in the interest of fairness and equity. One frequently quoted case is Gilford Motor Home v. Horne (1933) where upon leaving the employment of a company, the defendant agreed not to canvass business from the plaintiff’s customers. He subsequently formed his own company and used it as a vehicle for such canvassing with the courts holding he could be restrained from his actions. In Jones v. Lipman (1962) the defendant had agreed to sell his house to the plaintiff but later changed his mind forming a company and transferring the house to it. Russell J held that the company was a mere ‘device and a sham’ created solely to avoid contractual obligations.
When a company incorporates it enjoys certain benefits; in the eyes of the law it will be treated as a separate legal entity holding assets in its own name, will have shareholders who enjoy the protection of limited liability and may gain advantages in treatment of its taxes. It also accepts duties and responsibilities and those who abuse the principle as set out in Saloman’s case can be held accountable. It now seems that the courts are reluctant to pierce the corporate veil in the absence of fraudulent behaviour and ‘some shams or fa’ades may be obvious, but many others will not’ (Ohrenstein, no date, p. 14).
Since the principle of separate legal entity was introduced, many conflicting decisions have been handed down by the courts. This has prevented precise guidelines from being produced and whilst a case by case approach is favoured to determine if incorporation has been employed ‘for a fraudulent, illegal or improper purpose’ (Keane, 1991, p.123) it seems clear that ‘the rule in Saloman’s case is still the law (Keane, 1991, p.123).
When incorporating a private limited company, there exist requirements to lodge various documents with the Companies Registration office in Ireland. One such document is the Memorandum of Association which contains five compulsory clauses and amongst these is the object clause. The Principal Act provides that a company’s memorandum of association ‘must state the objects of the company’ (Keane, 1991, p. 54). At common law, and as a result of Ashbury Railway Carriage and Iron Co Ltd v. Riche (1875), this then restricts the company to carrying out those activities which it has declared and prohibits it from undertaking undeclared, ancillary activities.
Should a company act outside of that stated in its object clause it is said to be acting beyond its powers and the transaction is deemed to be ultra vires with the result that the transaction is void and cannot be ratified, even if all company members wish to do so. The basis for confining a company in such a way is to shield creditors and potential investors from ‘adverse consequences which might result to them from unauthorised use of the company’s assets’ (Keane, 1991, p. 54).
When considering that which is contained within a company’s object clause, it should be noted that in Attorney General v. Great Eastern Railway Co (1880) it was held that ‘whatever may fairly be regarded as incidental to or consequential upon those things specified in the memorandum as objects ought not, unless expressly prohibited, to be held by judicial construction to be ultra vires’ (Keane, 1991, p. 55). The difference between a company’s objects and its powers must also be considered. Most companies will have the power to borrow although this is generally accepted not to be an object of the company. In Introductions Ltd v. National Provincial Bank Ltd (1970) the defendant’s main object was the provision of entertainment and accommodation to visitors to Ireland. They later expanded into pig breeding, borrowing money to do so and the court held that this was ultra vires as was borrowing money for that purpose.
As a result of the Introductions Ltd case, memoranda were introduced containing a wide range of objects and powers, differentiating between both. In the construction of a company’s object clause a statement would be inserted to the effect that each object and power should be treated independently and not ancillary or subordinate to the others. This is known as the independent object clause and is often discussed alongside the ‘bell houses’ clause which resulted from Bell Houses Ltd v. City Wall Properties Ltd (1966). In the case, the company’s object clause authorised it to carry on any such activities which the directors believed would benefit the company. The objects clause was effectively left open-ended and gave discretionary power to the directors with the courts holding that a contract they had entered into, which was later disputed, not to be ultra vires.
The ultra vires rule caused difficulties for those dealing with companies since the memorandum of association is a publicly available document. Individuals or persons who dealt with companies were considered to be aware of the declared objects of a company; this is known as the doctrine of constructive notice. The case Re Jon Beauforte (London) Ltd (1953) illustrates both doctrines and the unfairness that can result. In the case, the company was a costumier and later began manufacturing veneer panels, an object not stated in its memorandum. When the company failed, a supplier of heating fuel claimed for monies owed on the basis he did not know it was to be used in manufacturing the veneer panels. The claim was not upheld as the fuel supplier was deemed to have constructive notice of the objects of the company as was contained within the publicly available memorandum of association.
A later amendment to the Principal Act reformed the effect of the ultra vires rule; should an outsider enter into a contract with a company which was acting ultra vires they may be able to enforce the contract provided they were not actually aware of the ultra vires nature of the contract. This is illustrated in Northern Bank Finance Ltd v. Quinn & Achates Investment Company (1979) in which a loan taken by Quinn was guaranteed by Achates. Quinn failed to make the required repayments and the plaintiff sought recovery of the funds from both defendants. It was established that the plaintiff had read Achates’ memorandum of association, it knew that Achates did not have the authority to guarantee loans of a third party and thus could not rely on the amendment to the Companies Act. The guarantee was decreed to be ultra vires and consequently unenforceable.
The amendment to the Principal Act was supplemented in the European Communities (Companies) Regulations 1973 which introduced a new element to the doctrine of ultra vires however it is limited to contracts entered into by directors of a company and applies only to limited companies. Where an outsider enters into a contract with a director, acting on behalf of a company, he does so in good faith even if he does not appreciate the capacity of the company.
Should a contract be deemed to be ultra vires the company, the entire transaction is void and in the event of a director making an ultra vires contract, they may be made to compensate the company should losses be incurred. By way of special resolution, shareholders do have the power to amend or restrict the objects clause, or adopt a new object, in their company’s memorandum of association and may wish to do so to prevent contracts which could be considered ultra vires.
Cite This Essay
To export a reference to this article please select a referencing style below: