Veil of Incorporation Serves to Encourage Rather Than Restrict

The veil of incorporation serves to encourage rather than restrict director innovation in managing a company. Likewise, the power of majority shareholders and rights of minority shareholders have little or no effect in removing or restricting director activity.

Evaluate the accuracy of this statement.

The assignment must be no more than 4,000 words in length.

In assessing assignments the following aspects are of particular importance:

a display of research skills

a clear identification of relevant issues

quality in analysis and evaluation

quality of communication skills.

introduction:-

What is a person? The English term, “person,” is ambiguous. We often use it as a synonym for “human being.” But surely that is not what we intend here. There are two persons under Law legal person and natural person. A natural person is any human being, with legal capacity commencing from the time of birth. A legal (artificial) person is an association of people or special-purpose fund (e.g. a foundation) that is recognized by law as having legal personality. A legal person is separate and distinct in law from its members and from their number or changeover. A legal person should have a legal name and has rights, protection, privileges, responsibilities, and liabilities under law. The concept of legal personality is one of the most fundamental legal fictions. This concept allows many natural persons to act as a single entity for legal purposes. We can see these concept almost all the legal systems.In general, a company can be defined as an “artificial person”, with a discrete legal entity, perpetual succession and a common seal. It is not affected by the death, insanity or insolvency of an individual member. A company is a form of organization. In the United States, a company is a corporation—or, less commonly, an association, partnership, or union—that carries on an industrial enterprise.” The remarkable thing about this entity is that it is created by process of Law and exists only by virtue of the Law. The most important legal characteristic of a registered company is that it is ‘incorporated’. Incorporation is the legal process by which an artificial entity is crated with legal personality. Its creation is evidenced by the certificate of incorporation by the registrar of company. By virtue of this incorporation the company has legal capacity so it can make contracts, it can sue and be sued, it may own property – the property belongs to the company not to the members, it has perpetual succession. It has limited liability –by shares or by guarantee. There are different types of companies under Company Law 2006.

Veil of incorporation:-

The term ‘Corporate Veil’ implies that the law presumes a distinction between the company and its members.  The two are considered as separate legal entities and thus a veil a line of demarcation exists between the two i.e. co. and its members. The veil of incorporation ensures that a company is a separate legal entity from its directors and shareholders, thus protecting the personal assets of owners and investors from lawsuits. It carries with it the concept of limited liability which ordinarily flows from the doctrine of corporate personality. The purpose of limited liablity is to promote commerce andindustrial growth by encouragr share holders to make capital contributions tocorporation without subjecting all of their personal wealth to the risks of the bussiness. It is established by case laws. Let us examine some importent case Laws.

Salomal v A salamon & co Ltd [1897] A.C. 22

In this case Lord Macnaghyen stated that the company is at law different person altogether from the subscribers to the Memorandum, and though it may be that after incorporation of the business is precisely the same as it was before and the same persons and managers, and the same hands receive the profits, the company is not in law the agent of the subscribers or trustees for them. Nor are the subscribers or members liable in any shape or form except to the extent and in the manner provided by the act.

Macaura v Northern Assurance Co Ltd (1925) AC 619.

Macaura owned a timber estate. He formed a company and sold timber to it for £42,000 paid for by 42,000 fully paid shares. Macaura insured the timber in his own name. There was a fire and the timber was destroyed.

The House of Lords held insurers were not liable on the contract, since the timber that perished in the fire did not belong to Mr Macaura, who held the insurance policy.

Lord Sumner said,

It was not his. It belonged to the Irish Canadian Sawmills Ltd, of Skibbereen, co Cork… He stood in no ‘legal or equitable relation to’ the timber at all… His relation was to the company, not to its goods, and after the fire he was directly prejudiced by the paucity of the company’s assets, not by the fire.

Lee v Lee’s Air farming Ltd [1961] A.C.12.

In this case the court held that, The company and the deceased were separate legal entities. The company had the right to decide what contracts for aerial top-dressing it would enter into. The deceased was the agent of the company in making the necessary decisions

While analysing above mentioned doctrine we can understand that “The veil of incorporation serves to encourage rather than restrict director innovation in managing a company”. Let us examine this statement by discussing the powers and duties of the Directors:

Director:-

The term “directors” has not been defined by companies Act (CA) 2006. But section 250 provides that the term include ‘any person occupying the position of director, by whatever name called’. So a director is recognised by his function, which depends on the nature of the company. Every company should have directors. By virtue of section 154 a private company should have minimum one director and a public company two. By virtue of section 155 at least one must be a natural person.

Types of directors:-

The following are the different types of directors:-

Executive and Non-executive Directors

Alternative directors

Shadow directors

De facto directors

Associate directors

Managing director

Nominee directors

Powers of directors:-

Although a company is a separate legal entity, it is not able to act in its own and make operations. It can operate only through its directors and officers. In practice the articles of association usually entrust the directors to manage the company and its business by providing them with full authority to exercise the company’s power to achieve this. However, in general law the directors do not have the power to act individually on behalf of the company. The decision must be made by the board as whole. But usually the article to permit the board collectively to appointment one or more of their number to the office of managing director or any other executive office and delegate certain tasks and functions to such persons and delegate any of its powers and duties to a committee consisting of one or more directors. CA 2006 retains the general principle that, subject to any statutory provisions that says otherwise, the article can provide which organ of the company exercise which powers on its behalf.

Let us examine the powers of a director:

Appointment and resignation of office:-

Generally to avoid the need to hold a general meeting, Article to provide power to directors to appoint new directors subject to the approval of the members of the next annual general meeting. At the same time he can resign by tendering his resignation to the company. However the articles will require the director to give reasonable notice of his resignation.

In OBC Caspian Ltd V Thorp 1998 SLT 653, OH

It was held that in the absence of any such provision a director can resign without the need for notice.

If the shareholders seek to remove a director before the expiration of his period of office then the director has the right to receive the notice of such resolution. More over the article usually provide directors the following powers:

Appoint and remove the company secretary

Appoint another director as their alternate to attend and vote at meetings of the Board.

Appoint or remove the chairman of board meetings.

Appoint one of them as a managing director. When a managing director has been appointed then he shall be entitled to exercise the powers of the board.

Appoint an agent

Delegate some of their executive functions to committees.

Authorise use of the company seal.

Meetings of directors:-

The directors are entitled to receive notice of directors meetings. It is usual for the articles to allow the directors to decide the manner in which their meetings are conducted and to permit any director to call a meeting. The chairman will preside over meetings of the directors and all directors have a right to vote. Resolutions are usually passed by simple majority and, unless restricted by the Articles or share holders agreement, directors have the right to one vote each. Resolutions usually passed by simple majority where there is no restriction by article or a shareholder’s agreement. Where there is an equality vote then the chairman can use casting vote.

Calls on partly- paid share:-

Subject to the terms of allotment the director ca cancel or postpone a call on members for unpaid amounts on partly paid shares held by them. Where a shareholder fails to pay the amount required by the call, the directors have the right to impose a lien on the shares for the amount outstanding and ultimately to sell the shares.

Transfer of shares:-

The directors have power to refuse to transfer shares to persons of whom they do not approve where the shares are not fully paid. Moreover right to refuse to transfer shares may be contained in the company’s article.

In Village Kay Mariana Ltd v Acland [1998] BCC 417

The court refused to intervene where the directors exercised this right for the benefit of the company.

In Re Inverdeck Ltd [1998] BCC 256

In this case the court decided that the director’s power of refusal has been lost because they were failed to notify the transferee about the refusal within two months.

Allotment of shares:

Before the enactment of Companies Act 1985 there was no statutory rule about the allotment of shares. The directors are authorised by provisions in the articles or by ordinary resolution of the members to allot shares. The director’s right to allot shares may be tempered by certain conditions in the articles or the resolutions.

Meeting of shareholders:-

In general the article provides to directors to convene general meeting of the members. That meeting may be the annual general meeting of a public company or a special business meeting. Moreover the article may provide the directors the following rights in respect of general meetings:

To receive notice of general meetings.

To attend and speak at general meetings and relevant class meeting.

If chairman is not present in a general meeting then chair the meeting.

If there is any equality voting, the chairman may be entitled to a casting vote in addition to his normal vote as a member.

If there is any adjourned meeting because there was no quorum present, then the date and place will be determined by the directors.

Power to make contract:-

By virtue of the authority provided by Articles to manage the Company the directors have the right to act as agents and enter into contracts and arrangements with third parties on behalf of the company. Sometimes the board may delegate this right to enter into contracts to one or more directors. However before they exercise their power they should ensure that they are acting within the company’s objects and within their own powers.

Payment of dividend:-

There is no specific provision in Company Act 2006 regarding the declaration of dividend. There is no requirement for a dividend to be approved by shareholders in a general meeting. If there is nothing to the contrary in the company’s articles, then the directors could declare an interim or final dividend under their general powers. But in practice a Company’s Articles contain provisions determining how dividends are to be declared.

Right remuneration :-

The directors have the right to receive remuneration and for reimbursement of all travelling, hotel and other expenses properly incurred in attending meetings. The Articles may specify an upper limit on total remuneration paid to all directors which must be observed.

In Re Arigna Iron Mining Co (1853) 1 Eq Rep 269

It was held that the right to remuneration may be waived.

In Hutton v West Cork Rly Co [1883] 23 Ch D 654, CA

It was held established that directors are not entitled to payment unless express provision is made in the articles.

Compensation:-

If there is any breach of director’s contract by the Company then the director can bring action for damages for breach of contract. Moreover if there is any unfair dismissal then they can claim. Where compensation is paid for loss of office which is not part of an award for damages made by the court and is not required by a clause in the service contract, such payment must be approved by the members in general meeting.

Access to records:-

By virtue of section 388(1)(b) the directors have the power to inspect the company’s accounting books and records.

It was established in Conway v Petronious Clothing Co Ltd [1978] 1 All ER 185 that a directors right to inspect and take copies of documents necessary to enable him to perform his duties.

Power to prevent disclosure of address:-

If any director is at serious risk of violence then he can prevent their home address appearing on the public record at Companies House.

Directors’ right of indemnity for expenditure incurred:-

A company’s directors are entitled to be indemnified by the company for all debts, expenses, and liabilities incurred in the ordinary course of business, and for money borrowed and applied for those purposes, together, in the case of an actual expenditure, with simple interest.

In PICKERING v. STEPHENSON.  (1872) LR 14 Eq 322 at 340 . It was held that the right to indemnity is limited to expenditure which has been incurred or an obligation adopted by directors on behalf of the company and in subjection to the special purposes of the company in accordance with its constitution.

Duties of directors:-

The Companies Act 2006 specifies the general duties that are owed by a director of a company to the company. The general duties are based on certain common law rules and equitable principles owed by directors to the company. The common Law principles must be used for the interpretation and application of the general duties.

General duties:-

The statutory statement contains seven duties. The following are the seven statutory duties under Company Act 2006.

Duty to act within powers:-

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. This duty applies to all directors’ action not just those exercised at board meetings.

In Hutton v West Cork Rly Co (1883) 23 ChD 654

It was held that a company’s directors may do whatever is fairly incidental to the exercise of their powers in carrying out the objects of the company

Duty to promote the success of the company:-

The Companies Act 2006 provides that a director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole.When making decision he must have regard (amongst other matters) to:-

the likely consequences of any decision in the long term

the interests of the company’s employees

the need to foster the company’s business relationships with suppliers, customers and others

the impact of the company’s operations on the community and the environment

the desirability of the company maintaining a reputation for high standards of business conduct; and

the need to act fairly as between members of the company

Duty to exercise independent judgment:-

a director of a company must exercise independent judgment. This duty is not infringed by his acting either in accordance with an agreement duly entered into by the company that restricts the future exercise of discretion by its directors, or in a way authorised by the company’s constitution.

In Clark v Workman [1920] 1 IR 107

It was held that the directors owe a duty to the company to exercise an independent judgment accordingly.

Duty to exercise reasonable care, skill and diligence:-

A director of a company must exercise reasonable care, skill and diligence. This means the care, skill and diligence that would be exercised by a reasonably diligent person with: (1) the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company; and (2) the general knowledge, skill and experience that the director has.

Duty to avoid conflicts of interest:-

A director of a company must avoid a situation in which he has, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company. This duty applies in particular to the exploitation of any property, information or opportunity (and it is immaterial whether the company could take advantage of the property, information or opportunity). However, the duty is not infringed if the matter is authorised by the directors, or by the shareholders, or by the articles.

Duty not to accept benefits from third parties:-

A director of a company must not accept a benefit from a third party conferred by reason of either his being a director, or his doing (or not doing) anything as director. This duty is not infringed if the acceptance of the benefit cannot reasonably be regarded as likely to give rise to a conflict of interest.

Duty to declare interest in proposed transaction or arrangement with the company:-

A director of a company is in any way, directly or indirectly, interested in a proposed transaction or arrangement with the company, he must declare the nature and extent of that interest to the other directors. The declaration may (but need not) be made either at a meeting of the directors, or by notice to the directors.

Duty under Common Law principles:-

According to common law principles a director owes two types of duty to the company (1) Fiduciary Duty (2) Duty of skill and care. Even though statutory statement replaced the common law rules and principles they remain important for interpretation and application of the general duties.

Fiduciary duty

The word fiduciary refers to trust and confidence. A fiduciary is someone who acts for or on behalf of, another person, in a relationship of trust and confidence, which equity protects by imposing on the fiduciary duty of loyalty.

Duty of skill and care:-

According to this principle when directors are acting in the company’s interest, they are expected to exercise whatever skill they posses and reasonable care.

Lifting the corporate veil:-

When we have discussed about the powers and duties of the directors we have understood that corporate veil is protecting the directors from the personal liabilities. But there are some situations where the judiciary or the legislatures have decided that the separation of the personality of the company and the members is not to be maintained. The veil of incorporation is said to be lifted. There are two existing theories for the lifting of the corporate veil. The first is the “alter-ego” or other self theory, and the other is the “instrumentality” theory. The alter-ego theory considers if there is in distinctive nature of the boundaries between the corporation and its shareholders. The instrumentality theory on the other hand examines the use of a corporation by its owners in ways that benefit the owner rather than the corporation. It is up to the court to decide on which theory to apply or make a melange of the two doctrines. Under the following circumstances the veil will be lifted;

Fraud or sham:-

These occur where individuals have used the separate legal entity to do something they are personally forbidden from doing.

Gilford Motor Co Ltd v Horne [1933] All ER Rep 109

H was a car salesman, and left G. His contract stated that he wasn’t allowed to sell to G’s customers for a period after leaving. H set up a company which then approached his former customers; H argued that firstly his company was approaching the customers, not him; and secondly, if thee was wrongdoing, his company was liable and not him.

The courts held that the company was sham, and granted an injunction against his company as well as him.

Jennings v Crown Prosecution Service [2008] UKHL 29

Fraud committed by four individuals – advance payments to company for loans where no loans would be provided. One wrongdoer, an employee prevented from dealing with property acquired in relation to the fraud.

In this case the Piercing of the corporate veil was recognised

Agency relation ship:-

If a subsidiary company is acting as an agent for its holding company, it may be bound by the same liabilities and rights of its holding company. However, no court has yet found subsidiary companies liable for their holding company’s debts.

Smith, Stone & Knight Ltd v Birmingham Corporation (1939)

SSK owned some land, an a subsidiary company operated on this land. BC issued a compulsory purchase order on this land. Any company which owned the land would be paid for it, and would reasonably compensate any owner for the business they ran on the land. Since the subsidiary company did not own the land, BC claimed they were entitled to no compensation.

The courts held that the subsidiary company was an agent and BC must pay compensation.