The Essence of the Doctrine of Corporate Personality - Case Study Example

 Company Law The decision of the House of Lords in the case of Salomon v Salomon & Co Ltd1 established the corporation as a distinct and separate legal entity in common law, with an existence and personality separate from its shareholders. This case firmly established that when a corporation is incorporated, a new and separate artificial legal entity is brought into existence, and this is the essence of the Doctrine of Corporate Personality. This separate identity that is accorded to corporations is a fictional one, since a company does not have a physical or spiritual existence on par with the individual status it has been accorded. This also allows a corporation to retain a permanent status, while its shareholders and directors may come and go; it allows the Company to sue and be sued, to hold property and be liable for its own debts. This has provided the facility for small agencies and businesses to assume a corporate form, functioning as a front that shields the agency/individuals from creditors rather than being purely directed towards raising capital for risky business purposes2. The corporation itself is a perpetual entity, existing until it is wound up and while individuals may deal with a corporation3, they cannot claim any interest in the assets or property of the corporation.4 The corporate body as an entity is impersonal and individuals may function in different capacities within an organization5, with their financial activities being shielded from the public eye, by virtue of the corporate veil. The net result of such a legal identity for a corporation is that it has created circumstances where personal greed may override ethical considerations. It also allows business firms to avoid liability to members of the public. From the perspective of social jurisprudence, the Doctrine of Corporate Personality can assist a corporation in avoiding liability, especially by channeling its risky activities into subsidiary companies and thereby absolving the parent company from liability. Analysis: In the case of Macaura v Northern Assurance Co6 the plaintiff Macaura was the owner of timber that was sold to a corporation, however despite insuring the timber in his own name, Macaura was unable to recover on an insurance claim when the timber was burnt. In this case, the Court demonstrated that while limited liability and corporate personality may produce huge advantages for shareholders, it also indicates that a Company is a separate legal entity with its own property and obligations.7 However in the case of Lee v Lee’s Air Farming, the New Zealand Court of Appeal held that his widow could not claim benefits under the Workers Compensation Act of the Company because her husband was the sole trader the corporation operated through. But when the case was appealed to the Privy Court in London, the judgment was that the Company and Mr Lee could enter into legal relations with each other because they were two distinct legal entities. Therefore, Mr Lee could be held to have entered into a contractual relationship with the Company as a pilot and could be defined as a worker with a separate identity, therefore his wife was entitled to workers compensation benefits. The two cases above illustrate how the Courts have applied the Doctrine of Corporate Personality differently depending upon the individual circumstances of the case. The Doctrine of Corporate Personality, which also imposes a limited liability on the officers of the corporation, has been strongly supported because it facilitates entrepreneurial activity.8 It is held to favor economic expansion in the market through encouraging investment. Since individuals are separate and distinct from the corporation, their liability is limited and this makes investors more ready to risk their monies. However this notion of corporate Personality has also been opposed due to the scope for its misuse. For instance, one company can become a shareholder in another Company by virtue of its separate legal identity. A parent Company exercises control over its subsidiaries, however despite this level of control, the parent company will be viewed as just another shareholder in the subsidiary Company’s business. Therefore, the parent Company will have limited liability for the losses incurred by the subsidiary Company. The establishment of corporate identity has brought into being a well settled principle in English Company Law that where a company suffers a loss due to a breach in the duty that is owed to it, then it is only the corporation itself that may sue for recovery of those losses. This was the case in Barings plc (in liquidation) v Coopers and Lybrand 9 where the parent company suffered a loss due to a loss at its subsidiary Company, however this loss was not actionable because the subsidiary itself was the proper plaintiff. As a result, Corporate Personality allows Companies to deliberately structure themselves through subsidiary activities in such a manner that all risky activities are shunted off to the subsidiary Companies operating in other countries in order to escape liability.10 Corporate powers have aggregated such that they are creatures of money with the single objective to “reproduce money to nourish and replicate itself”11 which is one of the major reasons why the notion of Corporate Personality is being resisted and condemned by social jurisprudence. In a report prepared by the Institute of Chartered Accountants of England and Wales, the ultimate profit objective of corporations has been clearly identified: Since profits are, in part, the reward for successful risk-taking in business, the purpose of internal control is to help manage and control risk appropriately rather than to eliminate it.12 Legal action by individuals against corporations becomes difficult and obscure. Government regulation does not play a significant role in undermining fund raising activity through exchange of securities, although most Stock Exchanges have the power to delist a publicly traded Company. For example, under UK law, the only recourse for a shareholder who has a dispute is to try and invoke an order from the Court under Section 459 of the Companies Act of 1985 to declare that the company’s affairs are being conducted in a manner prejudicial to shareholder interests, which is a time consuming, expensive option. In most cases, the behavior of corporations is not dictated in the belief that shareholders will themselves press for action against a Company that is in breach of the norms.13 Corporations stand to profit and escape liability by shunting off risky activities on their subsidiaries, however in some instances the Courts have prevailed in working to the benefit of social jurisprudence. In the case of Foss v Harbottle14 it was established that any breach of director’s duties would be the responsibility of the corporation. The Directors of a Corporation have a bona fide fiduciary duty to act in the best interests of the Company alone and not the individual shareholders15. In the case of Rolled Steel products (Holdings) Ltd v British Steel Corporation16 the precedent established by the Court was that powers given to directors by Companies must be used for the benefit of the Company and cannot be used for personal purposes such as keeping themselves sin control without any benefit to the Company as such. Similarly, in the case of Criterion properties plc v Stratford UK Properties,17an agreement was made by a managing director with a substantial shareholder which required the Company to buy out his shares if ownership of the Company changed. However, the Court held that this agreement was unenforceable against the Company, in order to prevent the shareholder from benefiting unduly from the transaction. In other cases, Courts have not hesitated to impute tortuous liability on corporations, despite the maze created by the doctrine of corporate personality. Baugh has pointed out how corporations have sought to benefit and escape liability for risky activities by relocating to developing countries: “The relocation of hazardous activities to the developing countries by multinational companies in the developed world has become a well-established feature of the global economy.18” But those who have sought to use the doctrine of corporate personality to escape liability have not always succeeded, because the Courts have paid attention to the complexities that arise in corporate group situations and judged in favor of social jurisprudence. One example is the case against Cape Industries plc, a multinational company established in England, which produced a settlement for claimants out of court.19 In this instance the parent company was sued in the English courts by Plaintiffs from South Africa where the offending subsidiary company was located, because exposure to asbestos and unsafe working conditions was causing cancer in the workers. Litigation in this case was protracted but finally resulted in the Cape Group making an out of court settlement with the victims, despite the fact that they could escape liability to shielding themselves under the veil of Corporate Personality. In this case, the defendants earlier sought to get a declaration of FNC from the House of Lords, arguing that the proper jurisdiction for the case was South Africa, however the House of Lords refused to grant a stay to the defendants on the basis that “the claimants would have no means of obtaining the professional representation and expert evidence which would be essential if these claims were to be justly decided.”20 In the interest of ensuring that justice was done to the victims, the Court in this case held the rights of the victims who were being exploited by a multinational corporation to be superior to the Doctrine of Corporate Personality which endowed the parent company with protection from liability for the risky activities being carried out by its subsidiary companies. In view of the above, it may be noted that the Doctrine of Corporate Personality, while being touted as a promoter of innovation and entrepreneurship, has actually resulted in instances of individual greed and the tendency for corporations to funnel risky activities away towards subsidiary companies in order to escape liability for them. This is the reason why it has been condemned as a crude and outworn doctrine. Within the global context especially, the activities of group corporations may lead to instances of torts in group situations and class action suits. A corporation as an artificially created legal entity does not share the same vulnerabilities as individuals, yet common law has viewed corporations and humans equally21. This imposes difficulties in criminal offenses where the mens rea of corporations cannot be evaluated like that of individuals22, neither has collective negligence23 of officers of a corporation been deemed to be actionable in tort.24 In the interest of justice, it may sometimes be necessary for the Courts to exercise discretion in allowing the Doctrine to stand, especially in those instances where it contravenes social jurisprudence. Since the law is so structured that individuals within corporations are often able to escape liability, and criminal liability in particular is difficult to establish, it is only through the eschewing of the doctrine in some instances as detailed above, that the courts have ensured that justice is done. Within the global context, where more and more corporations are now multinational, it becomes all the more vital that liability is established and that directors and officers of the Company are made liable for their actions. In some cases where maintaining the Doctrine of Corporate Personality would have produced an inequitable result, the Courts have therefore taken the necessary steps to ensure that liability is established, even within the existing parameters of corporate law. The system of corporate governance in the UK is weak25 but in Australia, company directors and officials can be delisted, further enhancing corporate governance, while in the United States, the existence of the Securities and Exchange Commission has provided for some regulation of the activity of corporations. Within the UK, it is the Courts that have recognized the problems inherent in the Doctrine of Corporate Personality and have responded with decisions that have sought to enhance the cause of justice for individuals, so that corporations and greedy individuals within them are prevented as far as possible, from seeking shelter behind the corporate veil. Ans 2: The legal issues that are raised in this case will be governed by the Companies Act of 1985 and 1993, as well as the new Companies Act of 2006, which sets out the duties of Directors to their Companies. A Director of a company does not have to be a natural person26 and directors are expected to act in the best interests of the Company27 and their decisions are to be conditioned by their own judgment of what they consider to be best at the time the decision is made.28 Therefore, on this basis, it may be argued that since the other two major shareholders, Frank, Charlotte and Mr. Wimpey, who together own 85% of the Company’s shares have agreed to support Karen in her decision, therefore they are making the decision that they consider to be best for the Company and as a result, the majority decision will supersede the opposition of the minority shareholders. These four shareholders who own the majority stock in the Company appear to have decided that it would be in the best interests of the company if Karen went after the P2A contract independently, since that company does dot wish to work with KFC. However, the minority shareholders may have a cause of action, based upon the rule established in Foss v Harbottle29 which provides minority protection in that a corporation can sue where a wrong arises that is ratifiable, and it is a significant precedent that can be relied upon by the minority shareholders. Although Wigram VC stated plainly that the Courts would be reluctant to interfere where a majority of the shareholders may ratify irregular conduct30, minority actions may be bought by the shareholders in instances where the misconduct or wrong in question has not been ratified by the majority. In this instance, the four major shareholders have voted against the proposal of the minority shareholders to bring action against Karen but their motion to pay Karen 50,000 pounds and allow her to leave has not yet been formally ratified by all the shareholders. In so far as the shareholders who own the 15% shares is concerned, they are minority shareholders who are facing a wrong that is about to be done to them, in that one of the directors of the Company is seeking her own gain at the expense of the Company. This will allow them to rely upon the precedent established in Foss v Harbottle allowing for minority protection. However the terms where this minority protection will hold valid were spelt out in Edwards v Halliwell31 and a fraud should have been perpetrated on the minority13, if such protection is to hold good and the majority votes of the corporation are to be superseded. In essence, while the natural rule is that the majority vote is the prime mover in deciding the fate of the Company and its decisions, minority shareholders will also have a say if they can show that a wrong is being perpetrated against them and that the alleged wrongdoers are the very same ones who are in control of the Company. In the case of Karen, she is one of the four primary shareholders of the Company and therefore exerts a significant degree of control over the Company. Her action is also contrary to the interests of the Company, and is akin to a fraud because she will not only gain monetarily from the contract with P2A Ltd, but is also going to be paid an additional 50,000 pounds by KFC Ltd. On these grounds, it appears likely that the minority shareholders may be able successfully pursue legal action against Karen. Secondly, another important aspect to be considered is the fact that in the case of KFC Innovations, Karen owns 20% of the shares and has also been functioning as the Director of the Company. Under Section 172 of the Companies Act of 2006, a new duty has been developed in addition to the existing group of fiduciary duties owed by a Director under the Companies Act of 1985 and its subsequent modifications. This duty is laid out under Section 172 of the Companies Act of 2006 and states that a Director has a duty of good faith to act in the Company’s best interest. While exercising this duty, the director is required to function in a manner that is most likely to promote the success of the Company and work for the benefit of its members as a whole. Included within the scope of this duty is the need to consider “the likely consequences of any decision in the long run, the interests of the company’s employees” and the need to “act fairly as between members of the Company.”32 Applying this in the case of KFC, it must be noted that the minority shareholders are also employees of the Company, therefore Karen also has a duty to act fairly to them and to consider their interests in the case of any long term decision that is being made. Karen may be found guilty of a breach of fiduciary duty that is expected of a Director because she has used her influence as a Director to derive personal benefits, not only by gain the contract with P2A Ltd but also in securing an additional 50,000 pounds compensation for herself. Purportedly for the loss of compensation from her role as Director despite the fact that she stands to gain from her contract with P2A Ltd33. Section 317 of the Companies Act of 1985 also places on directors a statutory duty to reveal any interest, profit or financial advantage accruing to them by virtue of their position. In this case, Karen is deriving financial advantages from both ends, by using her position to influence these gains. In the recent case of Chan v Zacharia, it was further held, as per Deanne J, that a fiduciary must not allow a situation to develop where there will be a conflict of his fiduciary duties with his personal interests and he/she must not make use of the fiduciary position to gain a personal advantage.34 However, this is exactly what Karen has done which may render her liable. The recent case of Bhullar v Bhullar has also re-established the court’s strict enforcement of the fiduciary duties of directors in the case of conflicts that arise when there is a clash of fiduciary duties and personal interests.35 In the case of Karen, a direct conflict is posed between her duty to KFC as its director, opposed to the personal financial benefits that she is gaining out of the contract with PA2 Ltd. In essence, her decision to leave the Company and seek to establish a relationship with another Company for the sale of profits amounts to a violation of her fiduciary duty. As established under Section 172 of the Companies Act of 2006, Karen is obliged to work for the good of the Company, however her personal contract with P2A is not going to benefit the Company KFC in any way. In the long term, it may even prove to be detrimental to KFC’s interests because the other Company could emerge as a significant competitor and cut into KFC’s business. Moreover, KFC is also being subjected to the loss of 50,000 pounds, in effect rewarding Karen for her defection from KFC to further her own personal gains. In such a case, it would directly affect the interests of the minority shareholders who are also employees of the Company. Therefore, there appears to be a good cause of action against Karen which the minority shareholders could have under Section 172, since she is violating her fiduciary duties under Section 172 and working against the long term interests of the Company and its employees. Karen may therefore be found guilty of a violation of the strict fiduciary obligation of a director not to profit from his or her relationship with the Company.36 Another aspect on which she may be liable is the 50,000 pounds she is trying to secure on leaving the Company. An attempt has been made to introduce increased regulation of Director incomes through the Directors Remuneration Report Regulations 2002. While existing listing rules already call for the listing of Director Remuneration, this has now been made a statutory requirement under the amended Section 234 B of the Companies Act, with a new Schedule 7A that sets out detailed information that is to be included in the Directors Remuneration report.37 Karen is trying to seek compensation for loss of office, when she is in effect setting out to profit elsewhere from her position as Director. The question of whether the rules limiting Director Remuneration will allow her to acquire such a large sum when she is not being unfairly dismissed from the Company does arise. With the strict regulation and limitation upon Director incomes, this amount will become questionable and it can also form a subsidiary grounds on which the minority shareholders can base an action against Karen. In view of the above, it may be inferred that the minority shareholders do have a good possibility of bringing about a successful suit against Karen. While it must be acknowledged that the support of the other major shareholders is a major factor working in her favor, since the majority decisions of a Company will be upheld in most cases, nevertheless grounds do exist for the minority shareholders to bring action. The rights of the minority shareholders may be upheld in this case because in effect, a wrong is being perpetrated against them and the interests of KFC. Karen is in direct violation of her fiduciary duty as a Director to work for the benefit of the Company and to ensure its welfare. Moreover, especially under the new scope of director duties that have been included with section 172 of the Companies Act of 2006, directors may be held responsible if they violate the duty to consider the long term benefits to the Company. As Goulding has also pointed out, directors are allowed to exercise their best discretion about what is best for the Company. However, in this instance it is not hard to determine that Karen’s decision to leave KFC in order to take up the contract with P2A is not going to benefit the Company. In the event that nay benefit is to be derived from the contract with P2A, then it is only Karen who will benefit because she has resigned her position as Director of KFC. Therefore any benefits accruing from her acceptance of the contract with P2A will not result in any benefit to the Company. Rather the Company is also paying out a large sum of 50,000 pounds in order to allow Karen to pursue her own interests. She is directly benefiting from her position as Director of KFC, which is what has gained her the contract with P2A in the first place. In consideration of all these factors, the Courts may hold that Karen’s actions are not bona fide and are not working to benefit the Company in any way. Furthermore, she is violating her duty to ensure the company’s welfare in the long term and to ensure the welfare of its employees. Since the minority shareholders are also employees, this will make their case stronger in their claim that a wrong doing and a fraud is being perpetrated upon the Company by Karen. The rule in Foss v Harbottle and Edward v Halliwell may very likely be successfully applied in this case and the minority shareholders may have a good cause of action against Karen and the majority shareholders. 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Sweet & Maxwell * Directors Remuneration Report Regulations 2002. * Ferran, E, 1999. “Company Law and Corporate Finance”, Oxford University Press * Institute of Chartered Accountants in England & Wales, (1999), Internal Control : Guidance for Directors on the Combined Code, London : Accountancy Books * Korten, D, 1995. “When Corporations rule the world”, San Francisco: Kumarain Press * Shutkever, Carol and Smith, Martin. The Directors Remuneration report Regulations 2002. [online] available at: http://www.mondaq.co.uk/i_article.asp_Q_articleid_E_19791 * Villalta G, “A Two-Edged Sword: Salomon and the Separate Legal Entity Doctrine” (2000) 7(3) Murdoch University Electronic Journal of Law, at p 5, [online] available at: http://www.murdoch.edu.au/elaw/issues/v7n3/puig73a_text.html * Watson, S, 2002. “Who hides behind the corporate veil? Finding a way out of “the legal quagmire” 20 Company and Law Securities Journal 198 Case law cited: * Administrator of the Estate of Rachel Jacoba Lubbe and 4 Others v Cape Industries Plc (2004) UKHL 41 * Barings plc (in liquidation) v Coopers and Lybrand (No 4) (2002) 2 BCLC 2004 * Bhullar v Bhullar (2003) EWCA Civ 424; (2003) WL 1202661 * Brown v British Abrasive Wheel Co (1919) 1 Ch. 290 * Chan v Zacharia (1984) 154 CLR 178 at 198-9; * Clemens v Clemens Brothers (1976) 2 All ER 268 * Cook v Deeks (1916) 1 AC 554; Regal (Hastings) v Gulliver (1967) 2 AC 134 * Costa Rica Ry v Forwood [1900] 1 Ch. 756 (HC) * Criterion properties plc v Stratford UK Properties (2002) BCLC 151 * Edwards v Halliwell (1950) 2 All ER 1064 * Foss v Harbottle (1843) 2 Hare 461 * Giles v Rhind CH 618 * Keech v Sandford (1726) Sel Cas Ch 61 * Lee v Lee’s Air Farming Ltd (1961) AC 12 * Lubbe v Cape plc (2000) 4 All ER 268 HL 277 at 279 * Macaura v Northern Assurance Co (1925) AC 619 * Percival v. Wright [1902] 2 Ch 421 * Re W&M Roth Ltd. (1967) 1 All ER 427 * Rolled Steel products (Holdings) Ltd v British Steel Corporation (1985) Ch 286 * Salomon v Salomon & Co Ltd (1897) AC 22 * Tesco Supermarkets Ltd v Nattrass (1972) AC 153 * Westinghouse uranium Contract (1978) AC 547 Read More