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The Company Is an Artificial Legal Person

Info: 5359 words (21 pages) Essay
Published: 12th Aug 2019

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Jurisdiction / Tag(s): UK Law

The company is an artificial legal person with its own property and have legal rights and liabilities as well as it can sue and be sued in its own name. The big idea of company law is separate personality as an artificial person. Therefore company itself is capable of owing property being a party to a contracts, and being a claimant or defendant in legal proceedings. As company has a legal separate entity and being an artificial person, the company is sufficient enough. However in order to prevent the abuse of company, the existing law are adequate enough, which are already discussed in this answer.

The company Act 1985 recognises a distinction between two different types of company: the private limited company (Ltd) and the public limited company (Plc). In United Kingdom (UK) most of the companies are private Ltd. The members of the every shareholder only liable for the amount unpaid on their shares and not for the debts of the company. Particularly the public companies are aimed at securing investment from the general public. The memorandum of a company must state it is public as with private companies the liabilities of members also limited. Incorporation of companies has been made readily available by parliament to those who wish to take advantage of artificial entities with separate legal entity.

A shareholder is a natural and legal person who invested capital in the company. The shareholder generally own right to vote and they can participate in the affairs of the company through the general meetings. Directors are the principle organ of the company. A company’s articles may sometimes require a director at first time. Particularly the directors also appointed by the general meeting by the shareholder. A company may have a wide range of interconnected relationships. They may connected by contract, by share ownership, or by interlocking directorships. Eisenberg identifies horizontal groups such as cross-ownership groups, which found in the Japanese traditional keiretsu is the most famous example. In this type of group there is a complex network of small cross shareholding.

The company with its unique nature facilitating investment, minimising risk, and providing a organisational structure the registered company seems to perform well. It is specially designed as a capital raising vehicle. The limited liability also helps to increase the commercial spirit of the directors. The company is designed to potentially have a large number of participant and also has a constitution (memorandum and articles of association.) outlining its basic organisational and power structure.

If a company needs a loan but a bank or other lender has some concern about the company’s ability then they can create a debenture, which secure the debt in two possible ways. First a fixed charge could be created conferring an interest in or over an asset of the company. On the other hand companies may not have fixed assets but because of the nature of their business they have valuable moveable assets. This brings second type of secured lending floating charge.

Now a days business are conducted not only in the form of a single private or public company , but also in the form of a group of companies consisting of a holding company have developed in size and complexity, it is not exceptional to find them controlling one or more subsidiary corporations. These subsidiary corporations may be for-profit subsidiaries, or in some cases even nonprofits subsidiaries. The relationship between a parent company and a subsidiary may create some typical problems for the parent company. As with larger groups of companies, different branches of the business will be located in each subsidiary. The Companies Act 2006 contains two separate definitions for groups of companies. For general purposes there is a definition of ‘holding’ and ‘subsidiary’ company. Another separate definition of the term ‘parent and subsidiary undertaking’ used throughout the 2006 Act.

“However S.1159 (1) of Company Act 2006 states, a definition of holding and subsidiary company as:

(a) Hold a majority of the voting rights in the subsidiaries or

(b) The holding company is member of the subsidiary and has the right to appoint or remove a majority of its board of directors, or

1162(1), (2) of CA 2006 defines the Parent and subsidiary undertakings as:

(a) It holds a majority of the voting rights in the undertaking, or

(b) It is a member of the undertaking and has the right to appoint or remove a majority of its board of directors, or

(c) It has the right to exercise a dominant influence over the undertaking.”

Considering these two sections it can be said that, although they representing almost the same criteria but whether any dominant influence is found under S.1162(c) it demonstrate by virtue of control contract rather than independent policy.

The logical from the creation of a separate legal personality is that, a separate legal personality and limited liability capable potentially of suing and being sued in its own name and logically therefore making any profit or losses that is companies own name rather than of its members or shareholder. This issue farmed as a limited liability. However these concepts, separate legal personality and limited liability are not the same thing. Companies are not human; they need to act through humans therefore accommodations had to be made to agency principles, fiduciary and statutory obligation and rights.

The separate personality of a company and its entity as distinct from its shareholders This principle was established by the House of Lords in Salomon v Salomon & co. in 1892 Mr.Salomon formed the company salomon & co Ltd. Salomon, his wife and five of his children held one share each in the company. He was the managing director of the company. The newly purchased company purchased the sole trading leather business. However things did not go well and with in a year Salomon had to sell his debenture to save the business. The company was placed in insolvent liquidation. The liquidator alleged that the company was a sham and a mere agent for Mr Salomon. Therefore Salomon was personally liable for the debts of the company. The Court of Appeal also agreed and 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 1862.

However the House of Lords(HOL)disagreed and it was held that, however large the proportion of shares and debenture owned by the one man even if the other shares were held in trust for him, the company’s acts were not his acts, nor were its liabilities or his liabilities. Other wise if he has sole control of its affairs a governing director. Also in IRC v Sanson it is important to note that House of Lords found no evidence, whatever of fraud or deliberate abuse of the corporate forum. In deed Salomon did his best to rescue his company by cancelling the debentures he took and reissuing them to an outside creditor who provided fresh loan capital. The Salomon decision gave express recognition to what were even then called one man the principle of Salomon case, that a company is a legal entity distinct from its members, is strictly applied by the courts whenever it is required to attribute the rights or liabilities of a company to its shareholders.

From this point on the separateness of the corporate personality from its members became firmly entrenched as a principle of English company law. In particular it had time to become embedded because until the House of Lords changed the rules under which it operated in 1966 it was not possible for the House of Lords to overrule itself. Therefore any attempts to strike at the principle were tangential and exceptional. However the principle in Salomon also illustrated by some cases. In Macaura v Northern Assurance co. The HOL found that, even though Macaura owned all the shares in the company but he had no insurable interest in the property of Timber Company.

Lord Wrenbury also stated that, “a member even if he holds all the shares is not the corporation and….neither he nor any creditor of the company has any property legal or equitable in the assets of the corporation.”

Particularly in the case of Gramophone and Type Writer v Stanley first challenge the separate legal entity doctrine with in groups of companies. In this case an English company held all the shares in German company. Therefore the Inland Revenue Commission argued that, the business was wholly owned by the English parent and that English company should therefore be taxed upon the profits accruing from the subsidiary’s operation. In order to proved this argument the commission had to show the German company is a fiction, a sham, or the German company is an agent of the English company. But the Court of Appeal rejected this argument on the basis that, ‘the German company was not at first and there is no evidence that it has ever become a sham company or a mere cloak for the English company.’ As well as in absence of an agency agreement the court found no evidence of agency. In applying Salomon principle in corporate shareholder court also found that the German company was a separate legal entity from the UK parent because as the subsidiary they hold the control over the Business.

Although in Salomon case concerned with small private company and run by an individual human trader, the basic principle also extended by the Court of Appeal to cover the more complex scenario of a multinational inter-corporate group enterprise where a controlling parent company operated its business through a number of smaller subsidiaries. Furthermore, the English Courts have persistently refused to affirm the validity of any alleged exceptions to the principle in Salomon bar in a limited range of cares. In particular, the courts have adopted a generally free market approach towards determining the legality of attempts by traders to exploit the legal machinery of separate corporate personality, in conjunction with members’ limited liability, in order to mitigate their personal liability towards creditors.

Theories of company existence are all important in the understanding of the appropriate corporate governance model. It is suggested that a convenient structure can be imposed by taking as a starting point three theories that have been influential in shaping models of companies. These are legal contractual theory, two or more parties come together to make a deal to carry on commercial activity and it is form this agreement that the company is born. The second group of theories to consider are the communitaire theories, which notice the grant of company status not only as a concession by the state but as creating an instrument for the state to utilise. These theories start from a position diametrically opposed to the individualist contractual theories. And the concession theory is a simplest form which grant the ability to trade using the corporate tool.,

‘According to Macaura case the principle of Salomon case has advantageous effects for shareholders. The price of this benefit is often paid by the company’s creditors. Where the Salomon principle had the potential to be abused or has unjust consequences then the courts or the legislature have decided to ‘lift the veil of incorporation.’ And in certain circumstances company will not be treated as a separate legal entity. Therefore now it needs to examine some situations how courts and legislature lift the veil of incorporation.’

In order to lifting the corporate Veil Ottolenghi offers such categories: “Peeping behind the veil that means the veil is lifted only to get the information that who controls the company. Penetrating or piercing the veil means to impose upon the shareholders responsibility for the company’s acts or established they have direct interest in the companies act. The third one is extend the veil by its extension over a large number of components. The most extreme form of lifting the veil is when the court ignores it completely. The courts have used various names like, cloak, sham, scheme, or puppet to describe a company which is not a genuine one.

The Companies Acts also have widely recognised that the corporate form could be used in relation to fraudulent purposes. However the 1985 Companies Act contained the criminal offences for fraudulent trading. And the civil provisions for fraudulent trading are now contained in sec 213 and sec. 214 of Insolvency Act 1986. However s.213 generally deals with wrongful trading. Where the courts required very high standard of proof for ‘intent to fraud’ which found in Re Patrick and Lyon Ltd there actual dishonesty involving according to current notions of fair trading. But this standard will be difficult to prove in practice.

Therefore in order to deal with the problem a new Provision was introduced in s.214 which concern with wrongful trading. This section requires that, ‘ a director at some time before the commencement of the winding up of the company, knew or ought to have concluded that there was no prospect that the company would avoid going into insolvent liquidation, but continued to trade.’ According to Re produce Marketing Consortium Ltd (no.2) here the two directors were liable because they did not put the company into liquidation in time. Therefore they had to contribute £75,000 to the debts of the company. However sec 214 does not directly affect the liability of members as it is specifically designed for directors.

There are some categories when the courts will lift the veil of incorporation .Where there is found sham or mere façade, when the company is an agent of another or tax issues or a group of companies exist. Others have attempted by the judiciary to lift the veil.

Corporate Manslaughter and Corporate Homicide Act 2007 introduces a new offence of corporate manslaughter. Sec1 of the Act sets out a new offence for convicting an organisation where a gross failure in the way activities were managed or organised results in a person’s death. Under sec.1 (4) (b) This Gross breach of the organisation’s conduct must have fallen far below what could have been reasonably expected. However, this Act also stated that, there is no individual liabilities under this act individual director will only be potentially liable under the common Law for gross negligence of manslaughter. Therefore it can be said that, the key weakness of the new law is the individual directors will escape personal liability unless they lift the veil under the Act.

According to Re Durby It is well established that the courts will not allow the corporate form to be used in relation of fraud. In particular the courts decided that, the company was a mere cloak or sham the only purpose of which was to enable the defendant to continue the breach of his restrictive covenant. In Jones v Lipman, the judge again found that, the company was a façade and granted an order for specific performance. Here the court states, the company was no more than ‘a device and a sham’ a musk which he holds over its face to avoid recognition by the eyes of equity”.

To piercing the veil in relation to agency ground Vaughan Williams J. who gives his judgement on the basis of Salomon principle regarding agency relationship. Where he stated that, the company had no personality of its own. As a consequence the House of Lords found a contradictory when the company is an agent. It had a personality of its own therefore the HOL denied the existence of such relationship. In Smith Stone & Knight Ltd v Birmingham Corporation the agency must be constructed on factual findings, where the holding of the share is only one of the key factors for the decision. Here the agency argument finding that, the subsidiary was not operating on its own behalf but on behalf of the parent company.

In Apthrope v Peter Schoenhofen Brewing Company Ltd there are two companies one is UK another is USA .The UK Company had dominant control over the other. Therefore the Revenue Commission claiming tax on UK for the US. But in applying the Salomon principle the Parents company found that there were two separate companies. In this context the court Found that, the US company carried on business as an agent for the UK principle. Therefore the UK parent was liable.

According to agency principle, It can be said that, the relationship is depends on the nature and degree of control being exercised.

However in 1969, Lord Denning in Littlewoods Mail Order Stores v IRC stated that his usually concise language considered in relation to the concept of veil lifting that:

“The doctrine laid down in Salomon’s case has to be watched very carefully. It has often been supposed to shed a veil over the personality of a limited company through which the courts cannot see. But that is not right. The court can and often does, pull off the mark. They look to see what really lies behind. The legislature has shown the way with group accounts and the rest. And the courts should follow suit…”

In relation to group structure, according to DHN Food Distribution Ltd v Tower Hamlets. Lord Denning also argued that, a group of companies was in reality a single economic entity and should be treated as one. In Woolfson v Strathclyde Regional Council after two years later disapproved the Dennings view in relation of group structure. And Lord Keith stated that “it is suitable to pierce the corporate veil where found it was a mere façade.”But, in DHN, The decision of Court of Appeal regarding single entity was for the purpose of compensation under the Compensation Act 1961.this is also an exceptional situation with its own fact.

However in 19th century the Courts were found that, he veil was to be harshly maintained. Thus in the complex case of Adams v Cape Industries Plc., the Court of Appeal strongly emphasized that the circumstances when the courts could lift the veil were very limited. The case is complex but widely examined the facts and circumstances of the case: The case concerned the enforcement of a foreign judgement in England. Cape and Capasco each company were part of the same group which traded through the subsidiary Adams in America. The case was concerned compensation claims by workers of the American subsidiaries for industrial injuries. The assets of the two American subsidiaries were limited therefore the claimants wanted to get the compensation from the UK companies. The problem arise the UK company could not fall with in the jurisdiction of America. Therefore it was necessary for claimant to established that the UK companies had in fact carried on business in America through the subsidiaries.

According to the Courts view, the veil could be only lifted either treating the Cape group as one single entity or finding the subsidiaries were a mere façade or the subsidiaries were the agents for Cape. I n applying above mentioned principle now it needs to consider whether the court could lifted the veil or not.

Considering the fact with the agency principle, here if the court could be established that the American companies were as an agent of the UK or they control the business as a principle according to Apthrope case then the action of subsidiary would bind the Parent. Moreover there was also no clear or express agency agreement between the holding and subsidiaries through the ostensible or apparent authorities. Examining the nature the court found that, the American company earned profits and paid taxes in the USA, it had no power to bind the parents to any contractual obligation. On the basis of these finding although the Adams was wholly owned by the UK companies, it was not UK’s agent.

Regarding the DHN Food Ltd case through the Denning Judgement it was not with in single economic entity. Also it was not based upon the interpreting of statute. Therefore it can be said that they are treated separate legal entity.

In applying the s.1162 of CA 2006 in Adams case, it was not found that, the UK Company exercised any dominant influenced over the US subsidiaries.

Moreover the question of group liability was also explored by the Company Law Steering Group (CLRSG). In observing the structure they proposed an ‘elective regime for groups’. At the option of the parent company, such an elective regime could be adopted in respect of wholly owned subsidiaries in the group. It is apparent that, this proposal was not concerned to address the problems of unsecured creditors or insolvent subsidiaries. It was designed to save the administrative cost for the group. In the Recent Company Law Review which resulted in the Companies Act 2006 after the long examined of legal regulation there was no evidence of abuse found by the parent company for debts incurred by the subsidiaries. And though there are already has adequate law but still they are failed to prevent the abuse in relation of group structure.

From the above it can be said that, English law still has long way to go before an inclusive doctrine of parent company liability for the acts of in a foreign country subsidiaries. So far the outcome of proceedings has clarified some of the issues relating to jurisdiction. It is now possible for an English law based parent company to be sued in the English forum for the acts of the subsidiaries. However the English law has not yet gone so far as to accept a mandatory rule of jurisdiction over the English dominated parents company for any unlawful act committed by their overseas subsidiaries.

Directors are the nervous centre of the company. Being directors they are the principle management organ of the company. Directors are stands at the midpoint of strategic management power. To resolve the corporate abuse excessive duty imposed on the directors. However because of their more responsibilities they give the strategic discretion on a daily basis to perform their business. However there are two type of directors: Executive directors and Non executive directors.

‘The UK statutory law is silent according to the role and composition of the board of directors. Under the existing unitary board, the duties of the executive and non executive directors are not formally separated. Both sit in the same board and collectively liable for the management of the company.’ An executive director is actively engaged in the affairs of the company where as the non executive director (NED) has occasionally involvement with the company.

To appointment the directors for a private company the draft model contain in Article 16, and for the public company Article 19, empower the members to appoint a person by ordinary resolution (51% majority vote) to be a director. In Re H R Harmer Ltd it was held that the power of the majority to appoint director must be exercised for the benefit of the company as a whole and not to secure some ulterior advantage. The draft model articles for a public company, Article 20 provides that a system of retirement by rotation for the directors at every third annual general meeting. Table A (SI1985/805) is a set of standard form articles of association, the articles are a formal document required to be registered by all companies which set out the internal workings of the company. ‘Although not in Table A, a company’s articles may grant powers of nomination or appointment on other people or bodies, e.g.: a holding company may be given power to appoint directors to a subsidiary company’s particular debenture holder or shareholder may be given power to appoint one or more directors.’

As directors are the agents of the company in order to prevent the abuse they owe three types of duties to the company as follows: Fiduciary duties, Common law duties and statutory duties.

The principle of fiduciary derived from the case of: Percival v wright where it was held that, directors owe the fiduciary duties to the company not to the shareholder, creditors, or employees.

In relation to the fiduciary duty equity has developed to ensure strict compliance with the over-riding principle. This principle refers that, fiduciaries must not benefit from their position of trust.

It was traditional under the common law to give a list of the breaches of fiduciary duty of directors under some headings such as:

  • Duty to act bona fide and in good faith in the interest of the company.
  • Duty to exercise their power for the proper purpose.
  • Duty not to put themselves into a conflict of interest.
  • Duty to exercise with care, skill, and diligence in the management of the company.

‘The duty to act in good faith in the interest of the company designed under sec 170 of CA 2006. In Re Smith & Fawcett Ltd, Lord Greene MR stated that, ‘the directors must exercise their discretions bona fide in what they consider-not what the court may consider-in the interest of the company.’

However in Regentcrest plc v CohenJonathan parker J observed that, whether or not the director’s act or omission was in honest believed in the interest of the company. Although under the statute directors are required to consider the employee’s interest but they are not oblige to preference to the interest of employee. But if the creditor’s interest intrudes at the point the company become insolvent they eventually cast a shadow on shareholders interest.’

Where a company is a part of a group or wholly owned subsidiary then there is a particular problem arises in respect of the director’s act in the interest of company which found in Lindgreen v L & P Estates. However if there the interest of company treated as a shareholders interest then the duty of the directors to the subsidiaries should translate simply into a duty to act in the interest of the parent company. In the case of Chaterbridge corp. v Lloyds Bank In applying the objective test, the only concession to the group structure is that, although, strongly, directors should specifically direct their minds to their company’s interest. Particularly in practice it may be very difficult for directors to decide what to do for the best and easy to criticise them with hindsight.

However, in Kuwait Asia Bank EC v National Mutual Life Nominees Ltd Lord Templeman stated that: ‘A director does not by reason only of his position as director owe any duty to creditors or to trustees for creditors of the company.’ This seems finally to organize of the possibility of creditors of a company taking action against its directors.

Sec 171 of Companies Act 2006 provides, Duty to act within powers for the proper purpose A director of a company must act in accordance with the company’s constitution, and only exercise powers for the purposes for which they are conferred. In Punt v Symons& co the courts have determined that, where the directors have this power the purpose for which it was best owed to raised the capital. This is a power one can be used for a take over and for the removal.

Duties of, care skill and diligence concerned in sec.174 of CA 2006 In the case of Marquis of Bute’s Case since the court was held that, the reliance on the chairman and general manager was reasonable and that the directors had not been negligent. The standard of the case was the director must have acted as a reasonable man. However, later the reasonable man test fully explored in Re City Equitable Fire Insurance that case is still regarded as important in this area although the courts have moved away from the subjective standards imposed to a more objective standard. According to Re City Equitable case the judge set out an important rules that, Directors need not demonstrate in the performance of his duties a greater degree of skill than reasonably expected from a person of his knowledge and experience.

However the DTI company law review observed that, an objective standard has been adopted in the general law by analogy with S. 214 of Insolvency Act 1986. in the case of Re D’Jan of London Ltd Hoffman LJ stated that, “ the common law duty of care owed by directors was accurately stated in s.214.

According to D’Jan of London case, S214 of the insolvency Act there is now a statutory definition of the requisite standard of care and skill a director should exhibit i.e.

  • That expected by a reasonably diligent person with the knowledge, skill and experience which may reasonable be expected of a director in his AND
  • Any additional knowledge, skill and experience which he has

Furthermore, Sec. 175 CA 2006 is based on two equitable principles, the no-conflict and no-profit rules, though it treats the no-profit rule as part of the no-conflict rule, as several of the cases do. However, the most significant circumstances in which the no-conflict and no-profit rules are applied in equity, to dealings between a fiduciary and the person to whom the fiduciary duties are owed. Furthermore, in Clark Boyce v Mouat, a fiduciary for one person must not enter into a position which imposes conflicting fiduciary duties to another person, without the informed consent of both persons.

In particularly, directors also owed such general duty to the company except the fiduciary duty,sec.172 (1) of CA 2006 codified that, in fulfilling the duty to promote the success of the company for the benefits of its members as a whole, a director must have regard to a member of matters listed in s.(172)(a) This may amount to a duty to take into account all material considerations, which has been recognised in Hunter v Senate Support Services Ltd. The Court of Appeal observed that: ‘the ordinary duty which the law imposes on a person who is entrusted with the exercise of a discretionary power: that he exercise the power for the purpose for which it is given, giving proper consideration to the matters which are relevant and excluding from consideration matters which are irrelevant.’ As well as section 172 (1) (b) provide that when the directors considering about to promote the success of the company for the benefit of its members as a whole, they must taken into an account of the interest of the companies employee.

However the new Companies Act 2006 though impose various duties by such statutory provision but this new Act give greater weight to employees, suppliers, customers, and the local community, who have long term relationships with the company.

The practical problem arise when a member of a company seeking to cure maladministration by a legal action. Some times the court permits a right of action of a company to be pursued in proceedings brought in the name of a company. Here company is the proper claimant in respect to proper claimant principle. This is also an exception under the majority rule which known as the rule in Foss v Harbottle. As explained by Jenkins LJ in Edwards v Halliwell there are limbs to the rule: ‘the proper claimant in an action in respect of a wrong doer to a company is prima facie the company itself. And, where the alleged wrong is a transaction which might be made binding on the company and all its members by a simple majority of the members , no individual member of the company is allowed to maintain an action in respect of that matter.’ Furthermore in Burland v Earle, it is well established that, a mere breach of the fiduciary duties that, directors owe to their company is rectifiable and hence cannot be the subject of minority shareholder action.

Considering the majority rule there were four e

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