The Concept of Corporate Personality - Article Example

Explain and evaluate the concept of corporate personality Corporate personality is basically a concept about a company or an organization being a separate legal entity i.e. separate from its owners. This is a vast concept which revolves around describing the company as a separate legal entity and lifting the veil of incorporation. The idea of corporate personality can be understood after understanding these two terms. (Separate legal entity and lifting of the veil of incorporation.) Separate legal entity refers to the company as being a separate entity from its shareholders. This means that the company can sue or be sued in its own name, hold any property in its own name and be liable to any debts itself rather than its shareholders. This idea basically suggests that the shareholders of that organization are bound to have limited liability. The only thing that the shareholders are liable for is to the unpaid amounts of shares and hence the company being a separate legal entity is held liable for all it due debts. (Ridley, 2009) The main concept of separate legal entity was developed when companies used this technique for their own benefit at the detriment of others in the society. The turning point of corporate personality was the decision of Salomon v Salomon1 where Mr. Salomon, leather merchant formed a company which included his wife, five children and himself (this was done to accomplish the requirement of shareholders as per the Companies Act existing at that time). Mr. Salomon appointed himself as the managing director of the company and subsequently purchased the sole trading business. However the valuation placed on the business being purchased was not fair, but this was due to his confidence in the business and not due to any mala fide intentions. The business was valued at £39,000 of which £10,000 was paid by issuance of debentures plus 20,000 shares at £1 each and £9000 in cash. After a certain period the company went into insolvent liquidation and a liquidator was appointed by the court. The liquidator evaluated that the company was a sham and a mere agent of Mr. Salomon and went on to conclude that he should be held personally liable to the debts of the company. The House of Lords reversing the decision of the Court of Appeal, which was a moralistic approach, stated that the fact that some of the shareholders were holding shares so as to fulfill a technicality was irrelevant and so the procedure which had been laid down by the Companies Act could be used by any person who in reality wanted to carry on what was in reality his own business. The Court further went on to state that if a company had been formed in accordance with the Companies Act, it was a separated legal entity and not per se an agent or trustee of the person who controlled it.(Dignam et al 2010) This case brought up a new revolution to the separate legal entity terminology and was included as an important aspect in the English Legal System. From that point onward, this aspect has become an important principle for every company or organization. The reason for the development has been cited to be the 1966 Practice Statement by many authors. There have been time when the corporate personality and the concept of separate legal entity has been disadvantageous to the person who incorporated the company in order to run a business which in reality was his own. The case for such an instance was the decision of the House of Lords in Macaura v Northern Assurance Co.2 where the claimant was unable to claim insurance for timber estate which had been destroyed by fire, which he sold to the company that had been formed for such purpose. The reason why such a claim was not given was because the claimant insured the timber in his own name and not in the name of the company, even though the plaintiff was the largest creditor and shareholder of the company, it was held that the company was the right person to have brought the action. (Davies et al 2008) Otto Khan-Freund3 in his article refers to such companies by stating that ‘sometimes, as shown by the cases concerning insurable interest “corporate entity’ works like a boomerang and hits the man trying to use it.” In Lee v Lee’s Air Farming4 it was held that a person who formed the company could enter into a contract of employment and therefore the person could act in dual capacities, the reason for which is the distinct legal entities of the person and the company.(Dignam et al 2010) The main advantage of incorporation of a company is the limited liability concept which flows from such formation, whereby the shareholders are held accountable only to the extent of unpaid shares and not to the overall liability of the company. However the concept of lifting the veil of incorporation has been developed so as to allow for proper checks and balances to be kept and this will now be discussed. Lifting the veil of incorporation is a principle which has been developed by the courts whereby the liabilities of the company and shareholders are treated as same, that is the shareholders are held accountable for the debts and liabilities of the company and the concept of separateness of shareholders from the company disappears. The principle is used normally when the company is formed for purpose of a sham or fraud. There has been considerable scrutiny of the veil lifting and criticisms on the approach of courts lifting the veil have flowed. In Adams v Cape Industries plc it was stated that the veil of incorporation would only be lifted where purpose of formation of company was for the purpose of a fraud which might include the intent to defraud creditors or in avoidance of an existing obligation of the person who formed the company . Parent companies had been found to be liable for the acts of subsidiaries where they acted as shadow directors or the controlled the decision of the subsidiary. However under normal circumstances both, the parent and subsidiary are treated as separate legal entities. In DHN Food Distributors v Tower Hamlets5 Lord Denning tried to create certain exceptions to the Salomon case and tried to establish the idea of a single economic unit. However, such an placation was later rejected (Woolfson v. Strathclyde)6. The idea of single economic unit was also rejected in Adams where the instances in which a parent company would be held liable for the acts of subsidiaries were laid down, one of them was the act of parent company indulged in the day to day activities of the subsidiary and the other was where the parent acted as shadow director of the company thereby making important decision of the company as the parent is involved in the management of the company. The courts have at times reiterated the fact that the moralistic approach should not be used and the veil should be lifted only in situation where justice requires (Trustor v Smallbone (No. 2)7. Thus resort is made to the mala fide intention test so as to evaluate the exact purpose of formation of the company and thereby the veil is lifted accordingly. Thus avoidance of restraint of trade clause by forming a company did allow for an injunction to be granted. (Gilford Motor Co. Ltd. V Home)8. The courts have found a company to be a ‘facade’ in cases where the intent had been to defraud creditors and so such a company is found not be existent.(Jones v. Lipman)9. These instances have been confined to what is known as the fraud exception’. (Davies et al 2008) There had been criticisms made on the rejection of the notion of single economic unit that had been laid down by Lord Denning which made parent companies to be liable to the acts of subsidiaries, as it was thought that such entities operated under the same umbrella and should have been held liable for the acts of each other. However, the rebuttal of the courts for such criticisms is the idea of preserving the concept of separate legal entity and limiting such acts to specific situations only. The doctrine has evolved over a long period of time and has now reached a stage where there is consistency in the decision of courts. The boundaries and the exceptions to lift the veil of incorporation had allowed for clear identification of the instances where the veil would be lifted. Therefore after considerable development of the principle of separate legal entity and identifying the instances where the veil of incorporation would be lifted has allowed the concept of separate legal entity to be a well established principle. References DAVIES, P. L., & GOWER, L. C. B. (2008). Gower & Davies: the principles of modern company law. London, Sweet & Maxwell DIGNAM, A. J., & LOWRY, J. P. (2010). Company law. Oxford, Oxford University Press TAYLOR, C. (2009). Company law. Harlow, Essex, England, Pearson Longman. ROSE, F. D., & ROSE, F. D. (2009). Company law. London, Sweet & Maxwell RIDLEY, A. (2009). Company law. London, Hodder Education. KEANE, R., & KEANE, R. (2007). Company law. Haywards Heath, West Sussex, Tottel Pub Read More