Seperate Personality and Limited Liability

Introduction

The concepts of corporate personality of the company as a separate legal entity, and limited liability of the shareholders are the two principles that can be regarded to be well entrenched in the English company law. The concepts were first laid down in the laws made by the British Parliament and these concepts went on to be entrenched in the English law due to the judgements of the courts, particularly the seminal case of Salomon v Salomon Co Ltd.[1] However, it would be incorrect to say that the principle of separate corporate personality was laid down in Salomon case because it was actually first laid down in the landmark case of Foss v Harbottle,[2] in which Wigram VC relied on the principle of distinct corporate personality of the company to declare that in suits involving the company, the proper plaintiff was the only the company and no one else. Shareholders could not be considered to be proper plaintiffs because the company was a legal person in its own right and not subject to the ownership by the shareholders. However, the Salomon case is considered to be a welcome clarification of the law of corporate personality and limited liability because it led to the decisive inter-relation between the two principles.

The concept of separate legal personality of the company was first provided in the Joint Stock Companies Act 1844. The Act provided that after incorporation, the company would be treated as a legal person, whose personality is separate from that of its shareholders. However until the Limited Liability Act 1855 was enacted, there was no concept of limited liability and the debts of the company paid by the shareholders, although that changed after the enactment of the Limited Liability Act 1855.

This essay considers the rules of separate personality and limited liability in the context of rights of shareholders vis a vis third parties. The essay uses statutory law and case law to discuss how well entrenched these rules are in the English law.

Separate personality and limited liability: Unfair advantages to shareholders

The disadvantages that can accrue to the creditors of the company and the unfair advantages that can accrue to the shareholders of the company due to the concepts of corporate personality of the company, or separate personality of the company, were realised after the judgement of the House of Lords in the case of Salomon v Salomon Co.[5] Therefore, any critical discussion on the concepts of limited liability and separate personality must start with the judgement and reasoning of the court in the Salomon case. A brief discussion on the facts of the case shows that Salomon who converted his sole proprietorship business into a company (Solomon & Co. Limited). The company purchased the business for £39,000, paid to Salomon and his family in part by issue of £10,000 debentures conferring a charge over the company’s assets.[6] Some money was borrowed from a third party who was an unsecured creditor for £5,000. The company was liquidated due to debts in a year’s time, however, as secured creditors Salomon and his family were paid the amount due to them on debentures, while the unsecured creditor received nothing.[7] In a suit by the unsecured creditor, he contended that the company was a sham, a contention accepted by the Court of Appeals but rejected by the House of Lords. In a classic statement on principles of company law, Lord Macnaughton observed:

“The company is at law a different person altogether from the subscribers to the Memorandum [shareholders] 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 a trustee for them. Nor are subscribers as members liable in any shape or form, except to the extent and in the manner provided by the Act”.

Therefore, the court held that once the company is incorporated as per the company law, it becomes a separate legal entity and any contentions that a company was a sham simply because it was controlled by one person, are incorrect.[9] In fact, one person companies were accepted in Gramophone & Typewriter Co. Ltd v Stanley, as properly constituted companies and not as agents of the shareholder in control of the company.[10] Recently, Companies Act 2006, s.7, also allows the setting up of companies with one or more persons. The European Community Twelfth Directive on Company Law (89/667) as well as the Companies (Single Member Private Limited Companies) Regulations (1992) have long provided for the one-man company. Incorporation is seen to be the evidence of the company’s separation from its members. The Companies Act 2006 provides the process of incorporation, and the law is a result of important reforms in the company law.

Therefore, in spite of the Salomon judgement being subject to much criticism for the unfair advantage accruing to shareholders due to the application of corporate personality principles, the Salomon case remains an important judgement in English company law, followed by courts around the world,[12] and the principle of corporate personality is also well entrenched in the company law.

As per the principle of corporate personality, the shareholders of a company are not to be treated as one with the company and they are not liable for the acts of the company.[14] At the same time, shareholders cannot exercise claims over the property or legal rights of the company. The company enters into contracts in its own name,[15] owns property,[16] and is responsible for the payment of its own debts. Corporate personality principle leads to the creation of a corporate shell, which is statutorily incorporated.[17] The difficulty with this position is that the shareholders may sometimes get unfair advantages over third parties such as creditors, as seen in the Salomon case. However, the criticism has not gone without response by the courts, which have tried to avoid such perverse consequences for the third parties by evolving the doctrine of the lifting or piercing of the corporate veil. By evolving this doctrine, the court has created some exceptions to the principle of corporate personality, wherein despite the separate legal personality of the company, the court fixes responsibility or liability on the shareholders or directors in the company.

The doctrine of piercing of corporate veil allows the courts to pierce the corporate personality of the company. The doctrine allows the courts to create some relief measures for third parties that may be adversely impacted by the doctrine of corporate personality. In Littlewoods Mail Order Store Ltd v IRC, Lord Denning emphasised that overlooking by the judge of the legal personality of an individual is shaped by the principle of corporate veil.[18] The principle of piercing the corporate personality has also found its way into statutory law. For instance, Companies Act 2006, s. 399 provides for re-consolidation of accounts of directors and company each year. During winding up, fraudulent trading can lead to responsible persons being made to contribute to the assets of the company.[19] Courts have applied the piercing of the veil in a variety of circumstances, showing that there can be exceptions to the rule of separate legal personality of the company. These circumstances have related to criminal law, contract law and the law of tort. In Moore Stephens v Stone & Rolls Ltd, [20] the court used the principle of ex turpi causa non oritur action, to allow the fraudulent intentions of the sole director be attributed to the company, in a marked departure from ordinary company law principles of corporate personality. In Jones v Lipman,[21] the court held that the company, which was created for the sole purpose of allowing a transfer of the house to be made to it instead of the individual so that the individual could avoid the sale of the house to another person under a contract, was a sham. Similarly, the court did not allow the individual to escape his liability to pay debt by creating a sham company in Thorne v. Silverleaf.[22] The doctrine of corporate personality does not only adversely affect the rights of third parties and there are times when the shareholders are impacted by the principle as well. This is particularly seen in cases involving minority shareholders who are unable to bring action against third parties for wrongs against the company due to the application of the Foss rule, or the proper plaintiff principle. The Foss rule is rooted in the distinct legal personality of the company.[23] However, this principle does not allow minority shareholders to take action if the majority shareholders do not allow such action to be taken place. The Foss rule is seen to be the principal impediment for minority shareholders’ actions.[24] However, over a period of time, exceptions have been evolved to the Foss rule as well showing that the doctrine of separate personality need to be modulated to fit the needs of the time, as articulated by Jenkins LJ: “the rule [in Foss v Harbottle] is not an inflexible rule and it will be relaxed where necessary in the interests of justice.”[25] In recent times, the doctrine of piercing of corporate veil has received a mixed treatment from the courts leading some scholars to question the relevance of the doctrine. Where in Lube v Cape Industries Plc,[26] the court applied the doctrine of piercing of corporate veil for allowing a suit against the British parent company of a South African subsidiary, by the employees of the South African company;[27] the courts have refused to apply the doctrine in many other cases. In Prest v Petrodel Resources Limited,[28] the Supreme Court held that the doctrine of piercing the corporate veil can only be applied in limited circumstances. The most common use for the doctrine is to be found where the corporate structure is being abused by the members of the company. In Ben Hashem v Ali Shayif,[29] the court held that corporate veil can only be pierced where some impropriety can be shown, by someone who is abusing the corporate structure for his personal benefit.[30] In VTB Capital plc v Nutritek International Corp,[31] the Supreme Court refused to hold that the person in control of the company cannot was also a party to the contracts that the company enters into. In Gramsci Shipping Co v Lembergs,[32] the Court of Appeal commented on the confusion surrounding the nature of the doctrine. Therefore, the rules laid down in Salomon with respect to the doctrines of corporate personality and the limited liability of the shareholders are still as important today as they were when they were used in the case. Because of the extent to which these rules are entrenched in the English company law, there are many areas of company law, such as rights of third parties and remedies of minority shareholders, that are impacted by the principles of corporate personality.

Conclusion

The rule relating to corporate personality is well entrenched in the English company law and has gone on to create a complex structure that is applicable to various areas in corporate law and governance that find their roots in the principle of separate corporate personality. Thus, third parties who have dealt with the company as creditors may find it difficult to contend that the company and the shareholders are one and the same person as was seen in the case of Salomon v Salomon Ltd. Moreover, at times the principle of corporate personality can even cause problems for minority shareholders as they may find it difficult to take action in the name of the company for wrongs committed against the company as the company is a separate legal person and the proper plaintiff in such suits as was held in the case of Foss v Harbottle. The cases themselves are old but the precedent created by them is strong even today. The reason for the strength of the precedent is that the decisions of the court was based on the doctrine of corporate personality which is a fundamental principle of company law.

At the same time, the courts have created structures by which relief can be given to the third parties by piercing the veil of incorporation, that is, considering that for certain actions, the company and the shareholders or directors are one and the same. This allows the courts to give some remedies to the third parties. However, the doctrine of piercing of corporate veil itself has come under scrutiny in recent times with courts holding that the doctrine is of limited application.

With respect to the minority shareholders, exceptions are created to the Foss rule, by which minority shareholders are allowed to take action in the name of the company despite the company being a proper plaintiff for such actions. Therefore, again it is seen that the rule of separate personality of the company cannot be taken to be too rigid so as to deny remedies to third parties like creditors, or even minority shareholders when such remedies are called for.

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