Legal Entity as Embodied in Salomon v Salomon & Co Ltd - Essay Example

?The Extent To Which The Doctrine Of Separate Legal Entity As Embodied In Salomon V Salomon & Co Ltd [1897] AC 22, Has Been Undermined By The Decision In Chandler V Cape Plc [2012] EWCA Civ 525 A Introduction More than a century ago, the British House of Lords established the maxim of separate legal entity in the case Salomon vs. Salomon & Co. Ltd (1897)12. In this case, the House of Lords ruled that a company is a separate legal entity that is distinct from the members who form it. This implies that once a company has been incorporated, it becomes distinct from the person(s) who formed it. In other words, the company has separate liability from its members and can sue or be sued in its own name. The doctrine has since been adopted as part of statutory provisions in many countries around the world. Even though the doctrine of separate legal entity established in Salomon vs. Salomon case is not subject to debate, some courts have made rulings that may appear to undermine the doctrine by lifting the corporate veil. While it is necessary that courts uphold and respect the doctrine of separate legal entity, there are situations that warrant the disregard of the doctrine. This paper will discuss the doctrine of separate legal entity and situations that may warrant its disregard in light of several cases. B Separate Legal Entity as established in Salomon vs. Salomon & Co. Ltd (1897) The case that particularly set precedence in regard to the manner in which incorporated entities are treated vis-a-vis their directors and shareholders is Salomon v Salomon (1897)3. In deciding the case, the House of Lords observed that once a company has been registered, even though the company may not remain the same as it was before with the same people receiving benefits, in law, a company can be an agent of its members. Following the landmark ruling, once a company has been incorporated, it immediately acquires legal status, according to Farat and Michon4. In other words, the company becomes a legal person, which is distinct from the members who form it. This implies that the company can do business even with the members who have formed it. In addition, this implies that a company once formed is free to employ even the shareholders of the company to take part in the running of the company. The House of Lords also held that once a company is incorporated, it acquires a legal status or personality that gives it the capacity to sue or be sued under its own name5. This implies that a company can file civil or legal proceedings against any person including the members who form it in its own name as noted by Talbot6. At the same time, the shareholders of the company can sue the company in its own name in case of breach. The House of Lords further noted that a legal entity in the form of a company exists perpetually; it is only when a company is liquidated or wound up that it stops to exist legally. This implies that the death of members of a company does not affect the existence of the company. Since the company is a separate entity, it will continue to operate even if all the members who formed it are dead7. This is attributable to the fact that the company will acquire other members such as through the issuance of shares or debentures to ensure its continuity8. The company can also employ workers in its own name to ensure its effective and efficient operation. Based on the precedence set by the House of Lords in Salomon v Salomon (1897) it is enshrined in English law that when an entity is incorporated, it is considered to be a separate legal personality. In this respect, the entity becomes separate from the individuals or organizations who take part in it. In other words, the owners and directors of the company or members of the company considered to be separate from the company. For a company that is limited by shares, the law assumes that it exists perpetually irrespective of the changes that may occur with respect to its constitution and membership. Furthermore, an incorporated entity can own any kind of property and hence has the capacity to buy and sell property in its own name. Yet again, the company can contract in its own name to the extent that its directors, members, and/or shareholders are not personally liable for its actions while partaking in a contract. This effectively means that the company is primarily liable for its actions whenever it enters into a contract with other parties. This also means that the incorporated entity can be sued or itself can sue other parties in its own name. C Lifting the Corporate Veil The existence of a legal personality separate from its owners, employees, members, and directors is one factor that makes companies a preferred vehicle for conducting business. Corporate bodies are partly formed to protect the personal assets of individual parties against the liabilities that may result from actions of the corporation as well as from personal liabilities. However, there are worries that some parties may use the corporate veil to commit fraud. This being the case, it has remained extremely difficult for courts to separate the company as a legal entity from its members in certain situations. In certain cases, courts have opted, for various reasons, to unveil or unmask the corporate bodies and assign liabilities to their shareholders, directors, employees, or members in what may superficially seem to be a contravention of the separate legal entity principle. More specifically, the courts have lifted the mask in cases where members have the potential to use the Salomon principle to commit fraud, if the company is a facade, or if applying the principle will have unjust consequences. Chandler v Cape plc [2012]9 is one case in which the court seemed to disregard the principle of separate legal entity as established in Salomon v Salomon10. The court ruled in favour of Mr. Chandler arguing that Cape PLC Company owed him a duty of care based on the precedence set in Caparo Industries Plc v Dickman11 12. In its ruling, the court made certain critical observations. Firstly, the judge observed that Cape plc knew of the working condition of its subsidiary as well as the health risks that the employees faced due to their exposure to asbestos13. Secondly, the court held that the parent company had significant control over the subsidiary to the extent that Cape plc owed a duty of care to all the employees of its subsidiary14. The ruling made by the Court of Appeal effectively lowered the threshold for intercompany liability. While emphatically rejecting the notion that the ruling impacts on the concept of lifting the corporate veil, the Court of Appeal noted that the case revolved around the relationship between a parent company and its subsidiary and whether or not the parent company had a duty of care based on its actions15. Critique of the Ruling on Chandler v Cape plc [2012] In making judgement in the case of Chandler v Cape plc [2012] judge Arden noted that the parent company and its subsidiary were two separate entities. However, based on the three-part Caparo test, the judge noted established that the parent company owed a duty of care to the employees of its subsidiary owing to the fact that the parent assumed responsibility over the subsidiary. Citing cases such as Connelly v Rio Tino Zinc Corporation, the judge noted that “a parent company may owe a duty of care to employees of subsidiaries” in as much as the parent company may not likely accept responsibility in respect of the subsidiary. Furthermore, the judge noted that Cape had in certain cases given instructions to its subsidiary on how to operate –instructions to which the subsidiary complied. Essentially, the court held that the parent and the subsidiary were the same to a reasonable extent. The court further held that the parent was bound to have superior knowledge on the safety and health issues relevant to the industry. Further, the court held that the parent was aware of the unsafe working condition that its subsidiary subjected workers to and should have used the superior knowledge in its possession to protect the employees of its subsidiary. Considering that Cape had advanced knowledge of the activities of Cowley Works and the risks associated with asbestos as well as its management, the judge noted that Cape had a duty to advise its subsidiary on the steps that it needed to take to ensure that workers were safe as it had offered advice to it in the past in respect of certain issues. In this sense, the court took a wider view at the two entities to reveal the relationship they had with one another. Chandler v Cape plc [2012] is quite similar to Adams V Cape plc 1990 in as much as the courts offered different rulings. While in the first case, the court ruled that the parent company was responsible for the actions of its subsidiary and therefore had a duty of care to its subsidiary’s employees, in Adams V Cape plc 1990, the court ruled otherwise insisting that it could not enforce judgement against the parent. In Adams, the court considered whether or not to perceive the entities as a single economic unit. The court further considered whether the subsidiaries were agents of the parent or not and analysed the situation from the corporate veil point. The Court of Appeal rejected the notion of treating the corporations as a single economic entity and held that the interest of justice did not feature as criteria for lifting the veil. The Court further held that that agency did not apply in the case much as sham and fraud did not apply in the same case. In making a ruling, the court noted that only three circumstances warranted the unveiling of a company; where a company is merely a facade, where a court is making interpretation of a statute, and when the subsidiary is an agent of the parent. While the judge upheld the principle set by Salmon v Salon in to Adams V Cape plc 1990, this was apparently not the case in Chandler. While the judgment made by the court in Chandler was consistent with the principle of common law in many jurisdictions including South Africa, it has opened a flood gate that has seen group companies have their veils lifted in tort cases such as those involving negligence, and criminal cases such as those involving fraud. Ever since the judgment was made, several group companies have had to bear the consequences of the actions of their subsidiaries. Furthermore, the ruling has seen the relationship between members of a company and the company as a separate entity viewed widely and more critically by courts. Relying on the precedence set by Chandler courts are sometimes unveil corporate entities for public good while trying to balance such actions with the principle of separate legal entity set by Salmon. D Impacts of the Chandler Case on the Doctrine of Separate Legal Entity The rulings of the courts in respect of Salomon v A Salomon & Co. Ltd. [1897] and Chandler v Cape plc [2012] have renewed debate regarding the scope of the corporate veil. The common law doctrine of separate legal entity may be subject to change with many implications for those who claim redress against others who may be hiding behind the relatively impregnable corporate veil as noted by Pearse, Sweigart and Adam16. In as much as the ruling in the Salomon case protects the doctrine of separate legal entity, Lord Halsbury himself took note of the fact that there are exceptions to the preservation of the veil of incorporation. In his words, the Lord Halsury stated that the concept of separate legal entity holds for as long as there is “no fraud and no agency and if the company was a real one and not a fiction or myth”17. The lifting of the corporate veil also came into effect in the case of Kosmopoulos v Constitution Insurance Co18. In this case, the judge, Justice Bertha Wilson, held that “the best that can be said is that the separate entities principle is not enforced when it would yield a result too flagrantly opposed to justice, convenience...”19. According to Pearse, Sweigart and Adam, a court may opt to deny a corporate status if the liability, rights, and property of the company are regarded to belong to another party as a consequence of statutory provisions, agency relationship, fraud, authority over someone else’s property or contractual relationship20. In Linsen v Humpuss (2012: 680)21, for example, the Court of Appeal noted that the corporate veil would be pierced if the company is used as a facade. The case of Adams v Cape (1990: 532) 22on the other hand brings into light the fact that the corporate veil may be pierced by a court if it appears that the subsidiary is in fact an agent of a parent company to the extent that the subsidiary has been created purposely to aid the parent company avoid its legal obligations. Alternatively, a court may lift the veil of a corporate body by considering the circumstances and facts that surround its existence with emphasis on its directors, members, and relationship with other companies within the same group23. Essentially, the court will disregard the corporate veil if it feels that a party is taking advantage of the law to for an unjust course. Several statutory provisions have also contributed to the undermining of the principle of separate legal personality. The Insolvency Act 1986 sections 213 and 214 specifically allow the lifting of the corporate veil and the disregard for separate legal entity in cases of fraudulent dealings. In this respect, the company directors must contribute to the payment of the company’s debts if they knew that the company had no reasonable prospect of avoiding insolvency and yet kept the business running to the point that its accumulated more debt. Another legislation that seems to undermine the principle is the Companies Act of 2006. According to the Act 2006 section 16(2), a company gets incorporated upon registering with the registrar of companies24. Once a company has been registered by the registrar of companies, it is issued with a certificate of incorporation as proof that it has been incorporated as outlined in section 15(1) of the companies act. Under sections 7(1), 7(2) and 16(2) of the Companies Act 2006, a company can be incorporated as a limited liability company subject to it having a legal aim25. When a company has limited liability, the Insolvency Act section 74 provides that its members are subject to limited liability. However, when a company is trading without a trading certificate, its directors are personally responsible for any liability that the company faces. Section 155 of the Companies Act 2006 requires every company to have at least one director. The director in this case must be a natural person. What this means is that in the event of insolvency, the director may be liable to creditors and other third parties if they or the company is at fault. Yet another situations that may lead to the lifting of the corporate veil is in the case of a parent company having two or more subsidiaries. For the purposes of taxation and accounting, the Companies Act demands that the different entities be treated as a single economic unit. Based on the precedence set in Chandler v Cape plc, courts are likely to consider group structures holistically as they make decisions that may relate to certain liabilities. It is evident from the case that a parent company may be subject to liability for the actions of its subsidiary a long time after the subsidiary has been liquidated. In this respect, it is prudent for companies and to conduct due diligence and ensure that they review their terms of insurance and operating procedures. Company directors will also have to clearly delineate between the decisions and activities of the parent and the activities of their subsidiaries. Furthermore, parties will have to consider the residual and contingent liability issues that may arise from parent companies as they engage in transactions that involve the sale or buying of a subsidiary entity. E Conclusion In Salomon v Salomon (1897), the House of Lords held that if a company has been incorporated, it becomes a separate legal entity according to UK law, its existence not comparable to its members. In this regard, a company is accorded equal treatment to that that may be given to any other independent individual. If for example, a sole trader incorporates his or her business and engages in contracts through the company as opposed to using his or her own name, then the company by law is not considered a trustee or agent of the sole proprietor. The existence of the new “person” that is the company survives its members, directors, shareholders, and employees for as long as it has not been liquidated or wound up. In as much as the Salomon case upholds the notion of separate legal personality, courts sometimes go to the extent of lifting the veil of corporation to establish the human faces behind the companies. Chandler v Cape plc [2012] set precedence in the lifting of the corporate veil by a court of law. This case while having a striking similarity with Adams V Cape plc 1990 saw the judge make a ruling that has been criticised by many for its effect. In Adams, the court ruled that the parent company cannot be compelled to bear the consequences of the negligence or omissions of its subsidiaries. The ruling on Chandler, however, was quite much the opposite. The decision to pierce the corporate veil by a court is often instigated by fraudulent dealings, cases of agency, and in light of statutory provisions. Courts in England have generally been reluctant to pierce the veil of the incorporation instead preferring to protect the doctrine of separate legal entity. In the few cases in which courts have had to treat members of an organization as part of the company ascribing the liability, the courts have insisted that the principle of separate legal personality is given due respect in coming up with rulings. In some cases, the subsidiaries wholly owned by a parent are considered a single economic unit for the purposes of taxation and accounting. References A Adam, SJ Pearse and RL Sweigart Assumption of responsibility for a subsidiary's responsibilities 2012 ‘The Law Society Gazette’. A Farat and D Michon ‘Lifting the corporate veil: Limited liability of the company decision-makers undermined? Analysis of English, U.S., German, Czech, and Polish Approach’ 2011 The Common Law Review, 21-25. 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Critical company law (Psychology Press London 2007) legislation.gov.uk ‘Companies Act 2006’ http://www.legislation.gov.uk/ukpga/2006/46/contents M George ‘Industrial disease - circumventing the corporate veil’ http://www.dlapiper.com/industrial-disease-circumventing-the-corporate-veil-05-10-2012/ (21 December 2013) Oxcheps ‘Aron Salomon (Pauper) Appellant; v – OxCHEPS’ http://oxcheps.new.ox.ac.uk/.../Aron%20Salomon%20(Pauper)%20v%20Salo… ? (21 December 2013) PP Gogna A textbook of company law (S. Chand New Delhi India 2002). R Chow ‘Singapore – The implications of Chandler v Cape plc’, http://www.conventuslaw.com/singapore-the-implications-of-chandler-v-cape-plc/ (21 December 2013) S Pearse, R Sweigart, A Adam ‘Assumption of Direct Responsibility for a Subsidiary's Liabilities – Is the Corporate Limited Liability Veil in Tatters?’ http://www.pillsburylaw.com/siteFiles/Publications/Alert20120809LitigationAssumptionofDirectResponsibilityforSubsidiarysLiabilitiesIstheCorporateLimitedLiabilityVe.pdf (21 December 2013) Law Teacher ‘Company Law: Separate Legal Personality’ http://www.lawteacher.net/company-law/essays/separate-legal-personality.php (21 December 2013) S Pearse, R Sweigart, A Adam ‘Assumption of responsibility for a subsidiary's responsibilities’ 2012 The Law Society Gazette http://www.lawgazette.co.uk/law/assumption-of-responsibility-for-a-subsidiarys-responsibilities/67165.article (21 December 2013) Read More