Disadvantages and Advantages of Incorporation Concept - Coursework Example

Task Concept of incorporation There are various sorts of businesses depending upon their formation, structures and even their day to day operations. Partnerships as well as companies are examples of such businesses and each of them exhibit their own advantages as well as detriments. However, the focus of this research is to critically analyze the advantages as well as the disadvantages that arise from a company having a distinct personality in law compared to partnerships that do not operate with a distinctive legal entity1. Operating as a distinct person in law implies that the company’s operations are done distinctively and that its shareholders do not meddle with its affairs, a concept that was first articulated in the case of Salomon V Salomon [1897] AC 22. This has been famously identified as the “corporate veil” which is at times lifted to make certain people responsible for their actions since though it is ran distinctively from the shareholders that own it; it should act in their best interest. In fact, it is through incorporation that a company becomes termed as a separated person and thus can even sue or even become sued upon its own name. In Salomon v A Salomon and Co Ltd [1897] AC 22, the concept of a distinct personality was given a clear definition. The gist of the case is that Salomon ran a sole enterprise. He then settled on the decision that he should sell the venture for 39,000 dollars to the Salomon Company, which he did. It happened that the Salomon Company constituted of He himself, as well as the wife and their five young ones. Every family member subscribed to a one dollar share. Salomon then went ahead and acquired more shares worth $20,000. However, the company was not in a position to pay for all of them but remained with $10000 unpaid for2. They furnished him with a floating charge guarantee by using their assets. Later on, the company ran into financial constrains and the liquidator was of the view that the floating charge should not be utilised but rather Salomon was to account for the debts owing for the company. However, Lord Halsbury concluded that once the company came into incorporation that marked the commencement of its identity as a distinct person with its own rights to enforce as well as liabilities to meet. He further elaborated that the persons that were concerned with its promotion were not the consideration in proving liability for the debts. The case thus laid the foundation that a company once incorporated had to be accorded treatment as separate person with a personality to safeguard by the way of rights and with liabilities to endure in their name. There have been various explanations leveled as to why incorporation is necessary. One of the major explanations is that it enables persons to undertake risky ventures through pooling together and running an entity jointly as opposed to commencing the business alone. The other reason is that it shields the shareholders from enduring liabilities that the company has to endure at any point by separating them from its operations. In addition, incorporation is championed because it enables members to invest their finances in a company without having the trouble of running it each day. In fact, the Lord Diplock articulated in the case of Dimbleby & Sons Ltd v National Union of Journalists [1984] 1 WLR 427 that incorporation enables shareholders to have restricted liabilities in the instance of the company ending up to financial constrains. Advantages of incorporation Limited liability Since the company operates as a distinct entity, the shareholders are not answerable to actions partaken by the company3. If anything, the shareholders become only liable to the company’s debts to the degree of unpaid shares owned by them. It is for that reason that the member’s liability is said to be restricted and any person cannot sue them directly to recover any claims that they may possess against the company. However, for a partnership, the members contribute to the debts of the partnership thereof directly and are not limited whatsoever by shares or anything. This concept as well applies with relation to holding companies in relation to their subsidiaries since the two are treated as distinct people as articulated in Dimbleby & Sons Ltd. v National Union of Journalists [1984] 1 All ER 751. Separate management A company’s daily affairs lay in its directors who are highly qualified and not the members themselves. Therefore, the company’s management is accorded to skilled people who handle every matter with extra expertise and this is yet another advantage tied to incorporation. However, in a partnership, the members are accorded with the task of running it directly, even in instances when they do not possess the rightful skills and expertise to operate the business. Property of a company The other merit is that property of the company belongs unto it and not its members; hence this is a merit for the company and not the shareholders. The company thus can acquire and hold the property using and in its name. It is for that reason that shareholders have no right to insure it as reinforced in the celebrated case of Macaura v Northern Assurance Co. Ltd [1925] A.C 619. In the case, M owned timber and then inquired with a company whereby he was the only owner to sell unto them. Because, he was the only owner, he undertook to insure the timber under his name and subsequently the timber got burnt up by fire. He then lodged claims to have reinstatement from the insurer. The House of Lords articulated that M could not get compensation since he lacked insurable interest with regards to the property since the timber was for the company and not under him4. It is for that matter that the company can deal with as well as dispose of its property as it pleases without having to adhere to any directions from the shareholders. However, in a partnership, the partners are also the owners of all of the partnership’s assets and property and thus can even insure it. Suing and being sued On its own name, a company can seek redress if it feels aggrieved by misdeeds of various persons. Through its name, the company is able to champion for the enforcement of all its rights in law to make those violating them liable. Contracting The company being a separate body on its own enters contracts. In that sense, since the company and the members are two separated segments the two can contract. In fact, this was given more light in the case of Lee v Lees Air Farming Ltd [1961] A.C.12. In that case, L owned 2999 of the whole 3000 shares for the company and he also stood as its director and the principal pilot. It happened that L perished while flying the company’s plane. Following his demise, the wife lodged claims to get reinstatement from the workman’s compensation claiming that the L was indeed an employee. The court reached the decision that L and the company existed distinctly and in that regard, he could come into an employee contract with himself5. Perpetual succession Another merit is that a company lives indefinitely6. Being a distinct segment from its employees, a company does not get affected in any manner when the shareholders die or when they suffer any disability or incapability. It thus thrives indefinitely and even acquires new shareholders in future times. Therefore, as for a company, its leadership and membership changes, but the company exists forever. This is unlike partnerships whereby the demise, bankruptcy, lunacy or even incapability of a partner may even culminate to its dissolution. Outside investment Since a company exists separately it has the autonomy to acquire investments outside it. This is due to the fact that there will be limited intrusion of its affairs by the members. The acquiring of further investment for the company can be advantageous and thus lead to the setting up of further shares. However, for a partnership, investments are a rare venture since any person who goes ahead to take up investment in the partnership may be regarded as a further member and thus become liable for any debts or losses experienced thereafter. This is the case because partnerships do not entail limited liability as compared to companies where member’s liability is restricted. Raising finance Basing from the fact that a company runs and exists differently, it can borrow by attaching a floating charge7. A floating charge is a situation whereby a company furnishes security for loan taken by attaching its properties. This is only possible because ownership of property is done by the company as opposed to its shareholders. Additionally, when a company has no sufficient assets, the directors may step up and offer personal securities over money borrowed by the company. Again, the loaners are at ease to allow the directors to furnish securities because, in the case of unpaid loans they will recover it from them without any interference from the members. However, for partnerships, the loaners are not at liberty to acquire payment because the creditors have direct access to the partner’s assets. Therefore, a company is in a position to acquire finances quite easily compared to any other sort of business for instance partnerships. Transferability of shares The other advantage attached to incorporation is the fact that since the members exist totally different from the company, they can freely surrender their shares to another subscriber or member who wants to buy them. This is unlike in partnerships where there exists no such transferability and the shares are non-existent. Disadvantages of incorporation Control As with a company, the shareholders are deprived of direct control of the company. This is because the existence of a company as a separated segment altogether is ran by directors as opposed to the shareholders. In that sense, the members are alienated from the daily operations of the company. All entire operations of the company are bestowed with the directors and so the members have no autonomy over what happens in the company. This is unlike in partnerships whereby the partners also double up as the managers of their entity and so have direct control over the operations. Ownership of property The other disadvantage is that the members do not have ownership of the company’s property. It is so due to the concept that the company has a separated personality and thus its property belongs to it and not upon the members and with that, the company can dispose and manage the property in their own volition and in the best manner they deem necessary. This is unlike in partnerships whereby the partners enjoy ownership over the assets of their entity and thus have some power to dispose of it in the manner that they agree. Formalities For companies, there exist many formalities that need fulfillment before it can come into existence8. For instance, for its formation, various documents need be drafted and filed with the rightful authorities for it to be given a go ahead. For instance, there could be drafting of such documents as balance sheets as well as statements depicting the company’s position at that particular point. This is unlike partnerships whereby the drafting of such documents is not a requirement and the agreement need not even be in writing9. The other formality comes about in the instance of dissolving the company whereby they have to undergo complicated procedures unlike for partnerships where such formalities are non-existent. Publicity The other demerit attached to incorporation is the fact that it has to make its affairs public for the inspection to everyone. For instance, the company has to ensure that they annually give statements to the registrar and this enables the public to be able to come and examine the documents to check out on the progress and position of the company. This tabling is mandatory for all companies unlike partnerships where they do not have to publicize their documents and affairs to the general public and thus there is no exposure of their dealings to non members. Expensive venture Setting up of a company as well as its managing is an extremely expensive affair. This is because of the many procedures that are entrenched in the daily operations of a company. Contrarily, in a partnership the operations are quite easy and there are no many formalities and thus it is also cheap to manage it. Exceptions to the corporate identity However, although incorporation sets out a company as having a separated identity, it is fundamental to note that this principle is not absolute and that it can be departed from by “lifting veil”10. This is advanced in order to make certain people liable for deeds undertaken by them. Lifting the veil can be through case laws as well as the statute. Lifting under statute Membership below minimum One of the instances is where membership falls below the required minimum stipulated by law. For instance, a public company should at the very minimal entail two members for it to operate, at the instance when this number falls below that, those responsible for allowing the entity run as such become answerable. Fraudulent trading The other instance is when the company runs fraudulently. A company runs fraudulently when it is unveiled that the directors brought it on its feet with the intent of defrauding creditors. In that instance, directors with the knowledge of such fraudulent operation become liable11. Abuse of name The other instance is when a company’s directors go ahead and commence another company with the name of a former company that ran into liquidation. Such directors become liable for utilizing the previous company’s name into subsequent company. Lifting under Case law when it’s a sham A company that has its operations illegally or for illegal motives12, its veil is perforated to make those responsible for its management answerable as reached in the case of Gilford Motor Co Ltd v Horne [1933] Ch 935. Establish an enemy identity At the time of war, a company is prohibited from trading together with enemy aliens13. For instance, if the company’s registration is in the UK and it’s controlled by aliens the there will be veil lifting to deal with such. This was given scrutiny in the case of Re FG Films Ltd [1953] 1 WLR 483. Evading liability Incorporation veil may as well be lifted in instances when the directors are evading liability for actions they are answerable to so as to make them liable as in the case of Re H [1996] 2 All ER 391 CA. Evading taxation In the case of Unit Construction Co. Ltd. v. Bullock, [1959] 3 All E.R. 831, court was of the view that a company that hides its identity so that it can escape taxation will face lifting of the veil. The persons responsible for such evasion are made personally answerable.14 In conclusion, it is undeniable that existence of a company as a separate person, concept that was first articulated in the case of Salomon v. Salomon, attracts multiple of advantages as well as disadvantages. For instance, the members entail limited liabilities with respect to a company, the property’s ownership is under the company’s name, and it leaves indefinitely. This is unlike in a partnership where the partners are agents to the company and actually have no limited liability. However, in applying the concept as articulated in Salomon V Salomon, it is important to note that this identity is not absolute it may at times be lifted to make certain persons liable for acts done by them. Bibliography Dimbleby & Sons Ltd. v National Union of Journalists [1984] 1 All ER 751 Gilford Motor Co Ltd v Horne [1933] Ch 935. Lee v Lees Air Farming Ltd [1961] A.C.12 Macaura v Northern Assurance Co. Ltd [1925] A.C 619. N. Bourne, Bourne on Company Law (6Th, Routledge, London 2013) 14 Re FG Films Ltd [1953] 1 WLR 483 Salomon v A Salomon and Co Ltd [1897] AC 22 T. K. Cheng, The Corporate Veil Doctrine Revisited: A Comparative Study of the English and the U.S. Corporate Veil Doctrines [2011] BCICLR 330, 342-345. Unit Construction Co. Ltd. v. Bullock, [1959] 3 All E.R. 831 Read More