Sam Liability for SamCom Ltd Obligations - Essay Example

?Sam’s Liability for SamCom Ltd’s Obligations Promoter Liability and Pre-Incorporation Contracts Sam is a promoter under the definition put forth by Twycoss v. Grant [1877] 2 CPD 469, as he was the person who filed for the articles of incorporation and got the new corporation started. As such, Sam stands in a fiduciary capacity to the shareholders of the company. Twycross establishes that promoters are individual to take the initiative to set up the company, arranges the finances and is responsible for the registration and formation of the company. Promoters also have a fiduciary duty to the shareholders, as he stands in the same position as a company director. As such, Sam cannot make a secret profit and he must have full disclosure with any transaction that he takes while he is the promoter of the company. He also cannot serve himself at the expense of the shareholders (Erlanger v New Sombrero Phosphate Co (1878) 3 App Cas 1218). The facts state that the business that became SamCom Ltd was valued at ?50,000, yet the business was sold to SamCom Ltd for ?90,000. This might be a breach of Sam’s fiduciary duty to his shareholders (Cahn & McDonald, 2010), if he did not disclose that his company was worth substantially less than what SamCom Ltd. paid for it. The solicitor who Sam hired to take the necessary steps for incorporation, however, is not considered a promoter, as Re Great Wheal Polgooth Co. Ltd. (1883) 53 LJ Ch 42 established that persons who are acting as a professional capacity at the behest of the promoter, such as solicitors, do not become promoters. As for the contract to buy the silicon chips for ?5,000, this is a pre-incorporation contract, and the company would not be bound on this contract. This was established in the case of Kelner v Baxter (1866) LR 2 CP 174, which established that pre-incorporation contracts do not bind the company. Section 51 of the Companies Act 2006 also state the pre-incorporation contracts do not bind a company unless there is a novation, which means that a new contract must come into existence after the company is incorporated, with the same terms as the old contract. The novation may be express or implied (Companies Act 2006 § 51). In this case, there did not appear to be a novation, in that there was not a new contract for the silicon chips that came into existence, either implied or express, after the SamCom Ltd. was incorporated, so the company would not be bound by this contract. Separate Personality of the Company and Lifting the Veil On the facts, it may be assumed that this is a closely held corporation. This does not, however, negate the separate legal personality of SamCom Ltd. According to established English law, a corporation is a separate legal personality who has the ability to sue and be sued and hold debts in its name (Wild & Weinstein, 2011). Moreover, the fact that only one person is a corporation does not defeat the separate legal personality of the corporation. This was established in the seminal case of Salomon v. Salomon & Co. [1897] AC 22. In this case, Salomon made leather boots, and he was basically the sole bona fide shareholder of his company. The company went into liquidation, and the creditors attempted to make Salomon personally liable for the company's debts. The Salomon court held that, as long as a company is a legal entity, then the business, and the debts, belongs to the company, not to the shareholder(s). In this case, the lower courts had attempted to say that Salomon himself was liable, because he was the only interested shareholder – the other shareholders were his family members, and they were disinterested. The House of Lords held, however, that this does not defeat the claim of corporate personality. Therefore, this case may be applied to the facts, in that SamCom Ltd. is a closely held corporation, but, as per Salomon, the corporation would still have a separate legal personality and Salomon further demonstrated that corporations, because they are separate legal entities, will be liable for the debts incurred by the corporation, and individual members would not be. Therefore, under Salomon, Sam would not be personally liable for the corporation's debts unless there is a reason to lift the corporate veil, as explained below. There are other cases which establish the principal of the separate legal personality of a company. Macaura v Northern Assurance Co [1925] AC 619 is one such case. In that case, Mr. Macaura had a corporation that owned lumber, but he took a personal insurance policy on the lumber. The lumber was destroyed, and Macaura tried to claim under the insurance policy. The House of Lords found that the timber belonged to the company and not Macaura. The reasoning that the House of Lords gave for this result was that Macaura did not have a “legal or equitable relationship to the timber at all.” In other words, the corporation, as a separate entity, was the only entity which had a legal relationship to the timber, not Macaura, even though Macaura was the sole owner of the corporation which owned the lumber, Irish Canadian Sawmills Ltd. Thus, Macaura established the principle of the corporation as a separate entity. Therefore, in applying Macaura to the facts at bar, SamCom Ltd. is generally going to be considered to be a separate entity, must like Irish Canadian Sawmills was in Macaura. As such, there would not be personal liability for Sam for the actions of the corporation – only corporation would be liable. Giles v Rhind [2003] 2 WLR 237 and Shaker v Al-Bedrawi [2003] 2 WLR 922 also establish the principal that, just as a corporation can hold debts of its own, it can also hold property of its own, and this property does not belong to the shareholders of the company. That said, even though companies are traditionally liable for debts, which means that shareholders are not personally liable for debts, and that the company may own property that is not the property of shareholders, there are exceptions. In these exceptions, the corporate veil may be lifted and the individual shareholders may be liable for the debts that the corporation incurred (Wild & Weinstein, 2011). The leading case on lifting the corporate veil is Adams v Cape Industries plc [1990] Ch 433. In Adams, the court states that, in order to pierce the corporate veil and to hold shareholders personally liable for a debt, that the company must be set up for fraudulent purposes. In other words, the company must be set up to avoid existing obligations, and the Adams court was careful to state that a company which is not set up to avoid future or hypothetical obligations would not be subject to having its corporate veil lifted. In cases where the company is set up to avoid future or hypothetical obligations, then it could be said that the company is a “mere facade,” which is one of the three scenarios where the corporate veil may be lifted. The other scenarios are when construing a statute, contract or other document, and when there is a subsidiary who is acting as an authorised agent of the parents (Lubbe v. Cape Plc. [2000] 1 WLR 1545). Since Adams established that corporate veil piercing might be appropriate when the corporation was set up to avoid existing obligations, therefore it is a “mere facade” of the entity who formed the corporation, this is what Mary must prove in order to pierce the corporate veil. Furthermore, the Adams court emphasised that the motive was relevant to examine when determining whether corporate veil piercing may be appropriate – in other words, what the motivation for forming the corporation? If Mary can show that the motivation for forming the new company was to avoid an existing obligation, then she would have a case for piercing the corporate veil. In using the Adams analysis, Mary would have a tough time showing that the corporation was formed to avoid an existing obligation. First of all, the stated motivation for the new corporation was that it was set up for commercial and economic reasons. The court will look to motivations, using Adams as a precedent, so if Sam can show these commercial and economic reasons which have nothing to do with Mary's suit, then this may defeat Mary's attempt to pierce the corporate veil. Furthermore, Adams states that a corporation is a mere facade if it is formed to avoid existing obligations. Mary was fired in June 2010, and the new corporation was formed in July 2010. Therefore, it is a stretch to state that an obligation to Mary existed at the time of the new corporation being formed. Therefore, under Adams, the corporate veil will probably remain in place. Other cases in which the veil was lifted because a corporation was a sham that was used to avoid existing obligations is Jones v Lipman [1962] 1 WLR 832 and Gilford Motor Co. Ltd v. Horne [1933] Ch 935. Gilford concerned an employee who was under a non-compete contract, then left the company and set up a corporation which directly competed with his former company, in violation of the non-compete contract that he signed. The defendant in that case claimed that the corporation that he formed was not bound by the contract not to compete, but the court in that case found that the corporation was set up to avoid the existing obligation of the contract not to compete, and, as such, was a sham. The veil was lifted. In this case, Gilford may also be used by SamCom Ltd. to lift the corporate veil on John's new company, titled Technical Services Ltd. John had a three year covenant not to compete, and this company clearly is competing with SamCom Ltd., so SamCom Ltd. can show that Technical Services Ltd. is a sham corporation that John formed to try to avoid his covenant not to compete. At any rate, if the veil is lifted, then Sam would be liable to Mary for damages, and this means that he would be personally liable. The other shareholders may also be liable to Mary if the veil is lifted, because, in that case, the corporation would not have liability, but the individual shareholders would. Another issue is that Sam kept trading under the name of SamCom Ltd, even after he knew that the company was insolvent. The question here is whether or not Sam would be personally liable for the trades. The Insolvency Act 1986 § 214 would govern this question. This section states that if an individual trades in the name of a corporation, while the corporation was insolvent and winding up, and that the individual knew that there was not a reasonable prospect that the corporation would avoid insolvency, and the person who was trading was a director of the company, then that individual would be required to make personal contributions to the company to cover the wrongful trading. The Insolvency Act 1986 § 213 further states that any business that is carried out with the intent to defraud creditors would mean that the individual might be liable for these trades as well. In this case, the corporation is not winding up, nor is it insolvent yet. Therefore, under Section 214, since the corporation was not winding up nor insolvent at the time that Sam was trading, then he would not be liable for the trades. The facts say merely that the company “could” go into insolvency, not that it did, so Sam can use this section to avoid liability. If Sam is deemed not to be liable for the trades, then the company would be liable. The fact that Sam was trading while his company was in danger of insolvency also implicates the Company Directors Disqualification Act 1986. This Act states that a director may be disqualified for, amongst other things, fraudulently trading or fraud which occurs during the winding up of the company. Therefore, if it can be shown that Sam committed a fraud during the winding up of the company, then Sam would be disqualified as a director of the company, which means that the director would be personally liable for the debts of the company, if he continues to act while he is disqualified. This is the ground for compulsory disqualification. Alternatively, the Secretary of State can ask the court to declare that the director be disqualified from an insolvent company if he is unfit. Among the criteria for unfitness is the misfeasance or breach of duties. Sam might be disqualified as a director if it can be shown that his new company is a sham company, therefore the trading done by this company is fraudulent, although this is a stretch. Alternatively, the better argument is that the trading done by Sam after the assets from SamCom Ltd. was transferred to Computer Solutions Ltd. is fraudulent, on the grounds that SamCom Ltd. did not have any assets, as they were all transferred to Computer Solutions Ltd., therefore the trading was fraudulent, as this fact was not disclosed to Sam's trading partners. Alternatively, even if SamCom Ltd. had some assets, it is safe to say that Sam did not disclose that the company was on the verge of insolvency to his trading partners, and this could be another basis for him being dismissed as a director. Conclusion Sam would most likely be personally liable for the contract made with Chips Ltd for the ?5,000 worth of silicon chips that he ordered from the company. This is because of the principle of pre-incorporation contracts and promoter liability. Since the company was not formed at the time that Sam entered into the contract, then the contract itself would be void unless Sam would be held personally liable, as he was an agent without a principal at this time. Since nullifying the contract is not an option, then Sam would be personally liable. Mary will probably not prevail on her claim. The reason for this is because she can probably not show that the new company was formed to avoid existing obligations of the old one. The facts state that the new corporation was formed for commercial and economic reasons, and these economic reasons might be existing obligations to other creditors, not just Mary. At any rate, the case might turn on when Mary filed her suit – if she filed it before the new company was formed, then she would have an easier case showing that the new company was formed to avoid the obligation to her. If the company was formed before she filed her suit, then she would have a more difficult time showing this, but still might be able to show that the company knew that she would be filing a lawsuit in the near future. Sam probably will not be liable for the contracts that he is making while the company is about to go into insolvency. Wrongful trading under the Insolvency Act 1986 is trading that occurs while the company is winding up and already in insolvency. Since this is not the case – the company was not winding up when the trading occurred, and not yet in insolvency – then this section of this Act would not apply. It would have to be shown that the trading was going on fraudulently, which means that creditors are defrauded, and this might be easier to show. That said, Sam may still be disqualified as a director, as he might have been fraudulently trading, and, since the Company Directors Disqualification Act 1986 does not turn on whether or not the company was insolvent at the time of the fraudulent trading, Sam could be disqualified under this Act. Bibliography Adams v Cape Industries plc [1990] Ch 433 Cahn, A. & Donald, D. (2010) Comparative Company Law: Texts and Cases on the Laws Governing Corporations in Germany, the UK and the USA. London: Cambridge University Press. Erlanger v New Sombrero Phosphate Co (1878) 3 App Cas 1218 Giles v Rhind [2003] 2 WLR 237 Jones v Lipman [1962] 1 WLR 832 Insolvency Act 1986 § 214 Insolvency Act 1986 § 213 Kelner v Baxter (1866) LR 2 CP 174 Macaura v Northern Assurance Co [1925] AC 619 Motor Co Ltd v Horne [1933] Ch 935 Salomon v. Salomon & Co. [1897] AC 22 Shaker v Al-Bedrawi [2003] 2 WLR 922 Twycoss v. Grant [1877] 2 CPD 469 Wild, C. & Weinstein, S. (2011) Smith & Keenan's Company Law: UK Edition. 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