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Separate Legal Personality Essay Sample

Separate Legal Personality Pages
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The incorporation of a company is an artificial person which exists as a separate legal personality. This separate personality means that the company is separate and distinct from its participants. The company needs to be treated like “any other independent person” with rights and liabilities, even if it is owned and managed by one man. It is capable of holding its own property and may sue or being sued in its own name. The company has perpetual succession which implies that it is able to carry on living regardless of death, insolvency or disagreement of a shareholder.

The case of Salomon v Salomon &Co Ltd [1897] had significant impact in Company law, as it firmly established the principle of “Separate legal personality”. In this case the Court of Appeal initially considered the company was simply an agent of Salomon, in order to allow him continue like before but with limited liability. This was contrary to the meaning of the Companies Act 1862, and so he should be liable for its debts. However, the House of Lords later overturned this decision. They held that the company was fully registered and constituted. Lord MacNaghten stated that “Though after incorporation the business may be 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.” Thus Mr. Salomon was completely separate from the company and as a result was entitled to be paid before other creditors as he held debentures. By compared to other debt, his secured debt had higher priority. Hence Mr. Salomon got to paid first.

At its most general level, the decision of the Salomon case seems to be a good one as it is benefit to both economic and society. The Salomon principle protects shareholder’s personal assets and reduces the exposure to personal liability, thus it stimulates more people to expand their business or investment. For instance one company is lawfully formed and is accused by another company, and lost lawsuit, shareholders of the defendant company will not need to pay the debts themselves. This is due to the status of separate legal entity, it is the company which conducts business and hence any decisions will not go against its shareholders as individuals. The shareholders are only liable on the amount of investment they have contributed to the business. Another benefit generates from the Salomon principle is that it makes trade easier when it contains complex organizations. Since company can create contracts in its own name, also profits can be shared without being involved in management and this is much simpler.

However, there are still some criticisms about the Salomon’s case as it seems unfair and immoral occasionally. First of all since Salomon’s personal assets is protected, he may pay less attention to deal fairly and honestly with third parties. Other shareholders may think the same as they do not need to face great risks of lose personal assets. Ultimately the entire economy may end up questionable. Secondly in theory company is an artificial body that can make independent decisions and investments, which if it is failed will lead to termination of a company’s existence. So in practice it is actually the shareholders and directors who make these decisions. It is the managing directors who are obtained unnecessary loans. It is the directors who suggested the shareholders about unsuccessful investments. Therefore by contrasting the two, the application of separate legal personality may seem unfair and immoral. Because the wrong doers, i.e. directors and shareholders are get to walk away free from their liability.

Although the principle of separate legal personality may seem favorable to the company’s shareholder and against its creditors, but in certain situations, the court does look beyond the principle, and this is called lifting or piercing the corporate veil. One of the expectations is where on the facts, an agency relationship does exist between a company and its shareholders. Smith, Stone & Knight Ltd v Birmingham Corporation [1939] gives a good example. In this case, the court recognizes that it is possible for a company to have agency relationship between their shareholders and thus lifted the veil. This happens because the subsidiary company works as agent for its parent’s company. There are few relevant factors to be considered in order to determine this issue. There are the profit of the subsidiary company should go into their parent’s company. The manager director for subsidiary company should be appointed by their parent’s company. And the parent’s company should be in constant and effective control of the subsidiary company etc.

Second situation where the court will ignore the principle of separate legal personality is that the corporate structure is a mere façade concealing the true facts. In the case of James v. Lipman [1962], Mr. Lipman regretted the contract he entered earlier for the sale of land, so he sold the land to the company he newly formed instead, in order to avoid his obligation. This newly formed company was merely a mask for Mr. Lipman to hide behind, hence veil can be pierced. Similarly in the case of Gilford Motor Co Ltd v Horne [1933], the company that he set up was used to enable him carry on with his business as well as to avoid liability. Therefore although company can be considered as separate and distinct from its shareholders, but if the purpose of it is to evade duties or being involved in fraudulent impropriety, the court will be willing to lift the veil of incorporation. But it will not be lifted just for justice demand.

The “single economic unit” theory is another category where courts have been prepared to lift the veil. The court ignores the separate personalities and examines the overall business operation as a single entity. A very classic example is the case of DHN Food Distribution v Tower Hamlets LBC [1976], in this case the subsidiaries accounts are considered as dependent of the parent’s company. Lord Denning MR stated that “this is especially the case when a parent company owns all the shares of the subsidiary, so much so that it can control every moment of the subsidiaries.” So for this kind of circumstance where the subsidiaries has to follow what parent’s company says, the court treats these group of companies as one concern and the will pierce the veil.

In conclusion, although some decisions generates from the principle of separate legal entity may have negative and immoral effects, but it did have massive contribution on improving economic and social wealth. And it is very difficult and complex to determine when the court is prepared to lift the veil of incorporation or not, because it really varies from case to case.

References:

[ 1 ]. Salomon v A Salomon & Co Ltd [1897] AC 22
[ 2 ]. Brenda Hannigan, (2009) Company Law, 2nd edition, p54 3-5 [ 3 ]. Brenda Hannigan, (2009) Company Law, 2nd edition, p57 3-12 [ 4 ]. Smith Stone & Knight Ltd v Birmingham Corporation [1939] 4 All ER 116 [ 5 ]. Brenda Hannigan, (2009) Company Law, 2nd edition, p57 3-12 [ 6 ]. Jones v Lipman [1962] 1 WLR 832

[ 7 ]. Gilford Motor Co Ltd v Horne [1933] Ch 935
[ 8 ]. DHN Food Distributors Ltd. v. Tower Hamlets London Borough Council (1976) 1 WLR 852 [ 9 ]. Cavendish Publishing, Company Law, 4th edition, p17

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