Sunday, April 29, 2012

corporate veil and separate legal entity


INTRODUCTION
The word ‘corporation’ is generally used for publicly owned companies. A corporation under Company law or corporate law is specifically referred to as a "legal person"- as a subject of rights and duties that is capable of owning real property, entering into contracts, and having the ability to sue and be sued in its own name[1]. The Corporations Act 2006 section 1(a) and (b) defines a corporation as:
(a) A company so formed and registered after the commencement of this Part, or
(b) A company that immediately before the commencement of this Part
                 (i) Was formed and registered under the Companies Act 1985 (c. 6) or  
 the    Companies (Northern Ireland) Order 1986 (S.I. 1986/1032 (N.I. 6)), or
               (ii) Was an existing company for the purposes of that Act or that Order, (which is to be treated on commencement as if formed and registered under this Act.”[2]
This process of formation and registration of a company in accordance with the legislation is known as “incorporation and once a company is incorporated, it has an identity of its’ own, known as “separate legal personality.”
CORPORATE LEGAL PERSONALITY
As a corporation is formed, a corporation becomes a legal person on its own, independent of its’ management and shareholders which is the concept of corporate legal personality. This concept of legal personality was established in the case of Salomon v Salomon & Co Ltd[3]. This doctrine is ancient, however the most valid and cited case is Salomon v Salomon & Co Ltd. The facts of the case are as follows:


Salomon v Salomon & Co Ltd:
Salomon had been in the boot and leather business for some time. Together with other members of his family he formed a limited company and sold his previous business to it. Payment was in the form of cash,shares and debentures. When the company was eventually wound up it was argued that Salomon and the company were the same, and, as he could not be his own creditor, his debentures should have no effect. Although earlier courts had decided against Salomon, the House of Lords held that under the circumstances, in the absence of fraud, his debentures were valid. The company had been properly constituted and consequently it was, in law, a distinct legal person, completely separate from Salomon.[4]

Lord MacNaghten of the House of Lords observed that:

"The company is at law a different person altogether from the subscribers to the memorandum and though it may be that after incorporation the business is precisely 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."[5]
In an Australian case, Peate v Federal Commissioner of Taxation, Windeyer J, in the High Court stated that a company represents:
“[A] new legal entity, a person in the eye of the law.  Perhaps it were better in some cases to say a legal persona, for the Latin word in one of its senses means a mask: Eriptur persona, manet res.”[6]
Though the concept of separate legal personality had been established years ago, however, courts realized the importance of the concept of corporate legal personality after the Salomon v Salomon case. By definition, corporate legal personality is defined as:
 Separate or corporate legal personality means that the artificial legal person, the company, can do almost everything a human person can do; it can make contracts, employ people, borrow and pay money, sue and be sued, among other things.[7]

Over a period of time, a number of similar other cases came in front of the courts which led to the provision of corporate legal entity being added to the Companies’ Act 2006. By CA 2006, s 15(1), on the registration of a company, the registrar of companies is to certify that the company is incorporated. A certificate of incorporation given under s 15(1)[8] and this legally establishes the corporate legal personality of a company. With the corporation treated as a separate legal entity, regarded as separate from the owner of the company, there are certain key effects that arise from this concept.
KEY EFFECTS
At least four points follow from the proposition that incorporated companies have a separate legal personality:[9]
1.    Company’s property
2.    Transferability of shares
3.    Perpetual succession
4.    Contractual capacity
5.    Limited liability
While certain books categorize these effects as being advantageous or disadvantageous; this, however, depends on the standpoint from which the value judgment is made.
1.    The company’s property: One of the major key effects of corporate legal personality is that the company’s property belongs entirely to the company (Gramophone and Typewriter, Ltd. v. Stanley[10]).Establishing the concept of ownership of assets is important when it comes to debts of the company which are undertaken on the behalf of assets and if these debts are not paid then claims can be brought against the assets.[11] So personal property of members and the company should be separate.
 In Macaura v Northern Assurance Co Ltd[12]:
 Five insurers refused to pay the appellant’s insurance claim on the ground that he did not have an insurable interest.  The appellant Mr Macaura had sold all of the timber then standing upon his land to a company, in which he was a shareholder and creditor, for £42,000. After the assignment, Macaura had insured the timber against fire damage by policies in his own name.  The House of Lords upheld the insurers’ refusal to pay.

Lord Buckmaster’s decision represents the Court’s view:

Turning now to his position as a shareholder, this must be independent of the extent of his share interest. If he were entitled to insure because he held all the shares in the company, each shareholder would equally be entitled if the shares were in different hands.  Now, no shareholder has any right to any item of property owned by the company, for he has no legal or equitable interest therein….[13]

Lord Wrenbury shortly observed that:

This appeal may be disposed of by saying that the corporator, even if he holds all the shares, is not the corporation, and that neither he or any creditor of the company has any property, legal or equitable, in the assets of the corporation.[14]

2.    Transferability of shares: A shareholder of the company is free to transfer his right in the company to another person. This can be done by selling the shares of the company. Shareholders can also transfer their shares within the company. In the case Millam v Print Factory (London) 1991 Ltd[15], the court of Appeal upheld the employment tribunal’s findings that there had been a transfer on the purchase of a company’s shares because of the extent to which that business had been integrated into the purchaser’s business.

3.    Perpetual succession: To put it simply, a company can survive the death of its’ members. Since the company is a legal person, it is not dependant on its’ shareholders. Hence, even if the members of the company are dead, even then the company can continue. The rule of perpetual succession is best seen in the case of Re Noel Tedman Holdings Pty Ltd[16] where it was established that even if the company loses all of its’ shareholders, it can still continue.[17]

4.    Contractual capacity: Since the company is considered as a separate person from its’ members, the company is free to contract with its’ members (Farrar v Farrars Ltd[18]). The most common case of company contracting with members of the company is buying the shares. When the investors buy shares in the company, they basically have contract of shareholding in the company. The case Lee v Lee’s Air Farming Ltd[19] develops this point.

Mr Lee incorporated a company, Lee’s Air Farming Ltd, in August 1954 in which he owned all the shares. Mr Lee was also the sole ‘Governing Director’ for life. Thus, as with Mr Salomon, he was in essence a sole trader who now operated through a corporation. Mr Lee was also employed as chief pilot of the company. In March, 1956, while Mr Lee was working, the company plane he was flying stalled and crashed. Mr Lee was killed in the crash leaving a widow and four infant children.
The company, as part of its statutory obligations, had been paying an insurance policy to cover claims brought under the Workers’ Compensation Act. The widow claimed she was entitled to compensation under the Act as the widow of a ‘worker’.[20]

The Judicial Committee of the Privy Council firmly rejected the insurer’s argument.  Lord Morris’ opinion is instructive:

In their Lordships’ view it is a logical consequence of the decision in Salomon v A Salomon and Co Ltd [1897] AC 22 that one person may function in dual capacities. There is no reason, therefore, to deny the possibility of a contractual relationship being created as between the deceased and the company.[21]

5.    Limited liability: One of the prime key effects of separate personality; it can be said that the concept of limited liability and separate personality go hand in hand. One of the main advantages of the principle laid down in Salomon v Salomon & Co Ltd[22] was the establishment of the concept of limited liability in addition to the corporate legal personality. This concept was a blessing in disguise as businessmen like Aaron Salomon could now protect their personal property from the company in case of the failure of the business.[23]
 As mentioned above that the company’s assets belongs entirely to the company, similarly, it is only the company who is responsible for its’ debts and not the shareholders. The legal existence of a company (corporation) means it can be responsible for its own debts. The shareholders will lose their initial investment in the company but they will not be responsible for the debts of the company.[24] Lord Sumner, in the case, Gas Lighting Improvement Co Ltd v IRC[25] clarified that it is the company as a separate person that owns the company’s property and enters into contracts and incurs debts.
In a recent Pakistani case Province of Punjab( through District Coordination Officer, Okara) v Market committee, Okara[26], the definition and key effects of corporate legal personality were mentioned by the Supreme Court:

In order to qualify as a "local authority" a body/institution should have a juristic personality distinct from its members; it should have perpetual succession and a common seal and may sue and be sued in its corporate name; it should exercise its authority and perform its functions within a defined territory.


VEIL OF INCORPORATION
The case Salomon v Salomon & Co Ltd[27] has been one of the most crucial cases in the history of English Company law. The case established the basis of corporate personality as well as limited liability; however, this decision is not uniformly approved. The distinguished commentator Otto Kahn-Freund called the decision "calamitous"[28]. The reason for the criticism of Salomon is, by and large, the opportunities which the decision gives to corrupt promoters of private companies to abuse the advantages which the Companies Act gives them by achieving a ‘wafer thin’ incorporation of an under-capitalized company and, further, to give even the apparently honest incorporators the advantage of limited liability in circumstances in which it is not necessary in order to encourage them to initiate or carry on their trade or business.[29]
Even though the courts have tried to trim down the unjust advantage corporators try to take from the limited liability principle; however corporators still try and hide behind the corporation. These cases give rise to the concept of “piercing” or “lifting the veil of incorporation.” Young J, in the case Pioneer Concrete Services Ltd v Yelnah Pty Ltd[30] defined lifting the corporate veil as:
 “That although whenever each individual company is formed a separate legal personality is created, courts will on occasions, look behind the legal personality to the real controllers."
In a similar Pakistani case, The president v Mr. Justice Shaukat Ali[31] the court held that:
"Veil of incorporation" no bar to Court to lift, pierce or rent, to determine true relationship of shareholders with regard to their dealings with Company or to ascertain true nature of Company itself-Court would not hesitate to lift veil of incorporation even where questions of public policy”
While in some cases, it is difficult to ascertain when the veil of incorporation is uplifted and when it isn’t, there are however 2 categories under which the veil of incorporation is lifted. They are: judicial veil uplift and statutory veil uplift. These categories are further divided into subcategories which will be mentioned later on.
Judicial veil lifting
 Judicial veil lifting is when the courts’ have the discretionary powers to lift the veil of incorporation. In Adams v Cape Industries plc[32]  it was decided that the courts can lift the veil of incorporation under certain categories. These categories are:
Ø  Agency;

Ø  Fraud;

Ø  Group enterprises;

Ø  Unfairness/justice


Agency: Under this category courts’ will lift the veil of incorporation when the personality of the agent company is ignored and the parent company is held liable for the acts of the agent company. This is done when the two companies are in an agency relationship and the principle company is held responsible for the acts of the agent company. Atkinson J gave a reasoned decision in the case Smith, Stone and Knight Ltd v Birmingham Corporation[33] where the implication of agency is found:
if ever one company can be said to be the agent or employee, or tool or simulacrum of another I think the [subsidiary company] was in this case a legal entity, because that is all it was. ... I am satisfied that the business belonged to the claimants, they were ... the real occupiers of the premises


Along similar lines is the decision in Re FG (Films) Ltd[34] where Vaisey J held that an English company with no significant assets or employees of its own was merely an agent or nominee for its American parent company.

Fraud: This is a general area of consensus where the courts will certainly lift the veil of incorporation if the company was registered for fraudulent purposes of dodging an obligation or liability (Gilford Motor Co Ltd v Horne[35]). Professor Ford observed that the main point in Gilford Motor Co v Horne, was that the veil of incorporation will be overlooked if there is an ‘unrebutted inference that one of the reasons for the creation of an intervening company was to evade a legal or fiduciary obligation.’ [36]
Subsequently the same principle lifting the veil of incorporation was seen in cases like Jones v Lipman[37] and International Credit and Investment Co (Overseas) Ltd v Adham.[38]

Group enterprises:  The argument of group enterprises is to the effect that in certain cases, some companies that act as a corporate group, may operate to hide behind the advantages of limited liability to the disadvantage of their creditors. They may operate in a way that the parent entity is not clearly distinguishable from the subsidiaries. The argument in favor of piercing the corporate veil in these circumstances is to ensure that a corporate group which seeks the advantages of limited liability must also be ready to accept the corresponding responsibilities. Roskill LJ stated, in the leading case on the matter of group enterprises, in The Albazero[39]:
... each company in a group of companies (a relatively modern concept) is a separate legal entity possessed of separate legal rights and liabilities so that the rights of one company in a group cannot be exercised by another company in that group even though the ultimate benefit of the exercise of those rights would enure beneficially to the same person or corporate body irrespective of the person or body in whom those rights were vested in law. It is perhaps permissible under modern commercial conditions to regret the existence of these principles. But it is impossible to deny, ignore or disobey them.[40]

Other than The Albazero, the main case cited in the issue of group enterprises is the DHN Food Distributors v Tower Hamlets London Borough Council.[41] Here, Lord Denning MR, observed that:
These subsidiaries are bound hand and foot to the parent company and must do just what the parent company says. ... This group is virtually the same as a partnership in which all the three companies are partners. They should not be treated separately so as to be defeated on a technical point. ... The three companies should, for present purposes, be treated as one, and the parent company DHN should be treated as that one

The Court of Appeal awarded DHN compensation for the disturbance to the business that the compulsory purchase caused.[42]

The authority of Lord Denning’s findings were doubted by Lord Keith in the Scottish House of Lords case, Woolfson v Strathclyde Regional Council[43], and further doubted and restricted in Adams v Cape Industries plc. To the extent that DHN might have been construed as authority for the proposition that the courts can generally treat closely connected companies in a group as one economic entity, ignoring their separate personalities, it must be conceded that the decision is no longer good law[44].

Unfairness/justice: In this case the courts’ will lift the veil of incorporation if it is felt that it is fair or just to do so. In the case, Re a Company,[45] the courts established the principle that:
“The court will use its powers to pierce the corporate veil if it is necessary to achieve justice.”

There may also be certain cases in which the members of a corporation might seek to get the veil of incorporation pierced to get the underlying reality of a situation, so that the unfair outcomes of a decision may be avoided. This example is cited in the case Harrison v Repatriation Commission.[46]

In the paper “From peeping behind the veil to ignoring it completely,” S. Ottolenghi described the different attitudes that courts acquire when the veil of incorporation is lifted.  These different approaches can be classified into four subtypes:
1.    Peeping behind the veil
2.    Penetrating the veil
3.    Extending the veil
4.    Ignoring the veil

Ø  Peeping behind the veil: Regarded as the least offensive of the 4 subtypes; peeping behind the veil aims to lift the veil only to obtain information in regard to the controllers of the company (shareholders) and proportion of their holdings. This is regarded as an act of curiosity by the courts and once the information is gathered, the veil is pulled back down and the company is treated as a separate legal personality once again (Wallersteiner v Moir [47])

Ø  Penetrating the veil:  The second category of lifting the veil relates to the courts reaching through the veil and grasping the shareholders personally (R v London County Council, ex p London & Provincial Electric Theatres Ltd[48]). This is done in order to impose upon the shareholders’ the responsibility of the company’s acts and establish their interest in company’s assets.
Ø  Extending the veil: The third technique of lifting the veil is by its extension; so that it embraces a bunch of companies. Here, the veil of each one of the components is lifted - only to draw it again over a large number of components (Re London Housing Society's Trust Deeds[49])

Ø  Ignoring the veil: The most extreme form of lifting the veil is when the courts ignore it completely. This approach is as a sanction to which the courts turn when they think that the company was not founded for commercial or other sound grounds, but only as a means to defraud or defeat creditors or to circumvent laws.
The author describes the four categories of Judicial veil lifting to be falling under the categories of peeping behind the veil, penetrating the veil, extending the veil and ignoring the veil. It is seen that “agency” falls under the category of penetrating the veil, “group enterprises” is under extending the veil and “fraud” and “unfairness/justice” comes under ignoring the veil.
Statutory Veil Lifting
Under statutory veil lifting, the Companies’ Act 1985 can set aside separate personality of a company and lift the veil of incorporation on the following basis[50]:
  1. The s 24 constitutes a minimum requirement for membership which companies must maintain in order to continue carrying on business.
  2. S 349 (4) articulates that an incorrect description of the company will allow the veil of incorporation to be lifted
  3. S 458 of the Companies’ Act and s 213 of the Insolvency Act place emphasis on fraudulent trading being an important reason for statutory veil uplift
  4. S 214 of the Insolvency Act 1986 for wrongful trading by a company director.
  5. S 216 of the Insolvency Act 1986 places a prohibition of the directors of an insolvent company being associated with a company with a similar name.
  6. S 177 (8) says that the veil of incorporation will be uplifted if the company starts trading without a trading certificate
  7. S 227 places an obligation on the Companies’ to file group accounts


REFORMS
The above discussion raises the issue of the current standing of the principle of separate legal personality and limited liability which was laid down in the case Salomon v Salomon & Co Ltd[51]? David Powles in his article “The See-through Corporate Veil” mentions that due to the contradictions of lifting the veil in the case of The Albazero[52] and   DHN Food Distributors v Tower Hamlets London Borough Council[53]; the current positioning of the Salomon principle is weakened. Also, judges like Lord Denning favor the idea of courts being always free to ignore separate personality. However, this does not mean that there is no current standing of the Salomon principle. Recent cases have shown that courts are now reluctant to lift the veil of incorporation and are concentrating more on strictly applying the Salomon principle. Lord Denning MR ruling in both Littlewoods Mail Order Stores Ltd v Commissioners of Inland Revenue[54] and Wallersteiner v Moir[55] was criticized by other members of the Court of Appeal as they did not agree on lifting the veil of incorporation.
CONCLUSION
In conclusion, it can be said that there is no unifying principle as to when the courts will lift the veil of incorporation and when they will not. However, due to the lack of a unifying principle, it can be seen that the Salomon principle is being applied more strictly.





[1]Section 3 (02) of the American Bar Association's Revised Model Business Corporation Act (RMBCA)
[2] companies act 2006’ ; http://www.legislation.gov.uk/ukpga/2006/46/pdfs/ukpga_20060046_en.pdf
[3][1897] AC 22 (HL)
[4] http://193.120.211.33/Ecom/Library3.nsf/FilesWeb/84A8D294CA8DEF5C80256E7E0042A339/$file/Chapter_9.pdf
[5] http://statutelaw.blogspot.com/2011/03/23-salomon-v-salomon-co-ltd-1897-ac-22.html
[6] Ian M Ramsay, “Piercing the Corporate Veil in Australia” (2001) 19 Company and Securities Law Journal 250-271

[7]Eavan Murphy;  “Business and company law for Irish students”
[8] Mayson, French and Ryan; “Company Law”;bookshop.blackwell.co.uk/extracts/9780199547050_mayson.pdf
[9] “Roach: Card & James’: Business law for business, accounting and finance students”; www.frontierlaw.com.au/Sites/192/Images%20Files/Lecture05.doc
[10] [1908] 2 KB 89
[11] Roach: Card & James'; “ Business Law for Business, Accounting, and Finance Students”
[12]  [1925] AC 619
[13] http://www.vanuatu.usp.ac.fj/courses/LA313_Commercial_Law/Cases/Macaura_v_NAC.html
[14] http://www.vanuatu.usp.ac.fj/courses/LA313_Commercial_Law/Cases/Macaura_v_NAC.html
[15] [2007] EWCA Civ 322; [2007] IRLR 526
[16] [1967] Qdr 561
[17] Roach: Card & James'; “ Business Law for Business, Accounting, and Finance Students
[18] [1888] 40 ChD 395
[19] [1961] AC 12
[20] http://www.londoninternational.ac.uk/current_students/programme_resources/laws/subject_guides/company_law/company_law_ch3.pdf

[21] Mayson, French and Ryan; “Company Law”;bookshop.blackwell.co.uk/extracts/9780199547050_mayson.pdf

[22] [1897]AC 22 (HL)
[23] Cotterell, The Sociology of Law, 2nd edn., (London: Butterworths, 1992), 126.
[24] http://www.londoninternational.ac.uk/current_students/programme_resources/laws/subject_guides/company_law/company_law_ch3.pdf
[25] [1923] AC 723
[26] Province of Punjab( through District Coordination Officer, Okara) v Market committee, Okara [2011] SCMR 1856
[27] [1897] AC 22 (HL)
[28] Modern Law Review titled “Some reflections on company law reform” [1944] 7 MLR 54
[29] Simon Goulding; “company law”; 2nd edition
[30][1986] 5 NSWLR 254
[31] PLD [1971] SC 585
[32] [1990] Ch 433
[33] [1939] 4 All ER 116.
[34] [1953] 1 WLR 483
[35] [1933] Ch 935
[36] Thomas Feerick, “Law of Associations 200018”
[37] [1962] 1 WLR 832
[38] [1998] BCC 134.
[39] [1977] AC 774 (HL)
[40] http://pntodd.users.netlink.co.uk/cases/cases_a/albazero.htm
[41] [1976] 1 WLR 852.
[42] Roach: Card & James'; “ Business Law for Business, Accounting, and Finance Students”
[43]  [1978] UKHL 5

[44] Mayson, French and Ryan; “Company Law”;bookshop.blackwell.co.uk/extracts/9780199547050_mayson.pdf

[45] [1985] BCLC 333
[46] Unreported, Administrative Appeals Tribunal, Barbour SM, 18th October 1996
[47] [1974]3 All ER 217
[48] [1915]2 KB 466
[49][1940]Ch 777
[50] Nicholas Bourne; “Principles of Company Law”
[51] [1897] AC 22 (HL)
[52] [1977] AC 774 (HL)
[53] [1976] 1 WLR 852.
[54] [1969] 1 WLR 1241
[55] [1974]1 WLR 991

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