Corporate Personality - Essay Example

Corporate Personality Explain and evaluate the concept of ‘corporate personality’, considering the attitude of the courts to this important part of company law. Corporate personality is a part of company law that has steadily developed over a number of years by crucial scrutiny by courts. Corporate personality tends to cover the doctrine of separate legal entity and the lifting of the veil of incorporation. An explanation of these concepts will be done first and then the approach of the courts will be discussed and concluded upon. The term corporate personality has erupted from the notion of a company being formed and coming into existence which allow the company to hold property in its own name, bring an action against anyone in the court, in its own name, and be liable to debts and liabilities that have been incurred by such a company. The most important concept that flows from the incorporation of a company is that of limited liability whereby the shareholders tend to be liable only to the unpaid amounts of shares and so the company as a separate legal entity is held accountable for its own debts. Corporate personality has been in use for a long period of time but the area of law developed when small businesses used the notion so as to create limited liability. The turning point of corporate personality was the decision of Salomon v Salomon1. In Salomon, a leather merchant incorporated a company and completed the formalities by appointing his family members as shareholders which was a requirement of the Companies Acts at that point in time. In his personal capacity, he appointed himself as managing director and subsequently purchased the sole trading business. The main concern was the over valuation of the business placed by him, but this was mainly due to his confidence in the success of the business. The company subsequently went in to liquidation and a liquidator was appointed by the court who in turn evaluated that the company was a sham and had been used as an instrument to defraud creditors. The Court of Appeal accepted the evaluation of the liquidator, however, the House of Lords reversed the decision stated that the Court of Appeal had used a moralistic approach and went on to say it was irrelevant that some of the shareholders were used merely to fulfill a technicality and so the use of corporate personality could be made by any person who intended to pursue what was his own business and thus the company set up in this case found to be a separate legal entity and not an agent or trustee of the person controlling it.2 The case set a cornerstone for the doctrine of separate legal entity and separated the company from its shareholders. This concept has developed from that stage and has now become an important principle of company. On of the reasons cited by many for the development of the doctrine is the fact that the case had a lot of time to develop as the case had been decided well before the introduction of the 1966 Practice Statement, which gives the House of Lords the power to change its own decision.3 The doctrine of separate legal entity has at times been disadvantageous to the person who actually formed the company so as to function a business which in reality was his own. This can be seen in the decision of the House of Lords in Macaura v Northern Assurance Co.4 where a person who formed a company and sold it his timber estate. The timber was destroyed by fire and the insurance company refused the claim because the insurance had been taken out in the name of the person and not the company and the insurance company argued that the company was the right person to claim for the damages suffered. Even though the plaintiff was the only shareholder and the largest creditor of the company that he had formed, the court agreed with the insurance company’s argument and said that the company is the rightful owner of the assets under the concept of corporate personality.5 These type of case have also been discussed Otto Khan-Freund6 where he says that ‘sometimes, as shown by the cases concerning insurable interest “corporate entity’ works like a boomerang and hits the man trying to use it.” Lord Morris in Lee v Lee’s Air Farming7 said that even though person forms a company, he can still enter into a contract of employment with the company and so a person can be involve with the company in dual capacities that is forming the company and entering into a contract of employment, this is so because the company and the individual are distinct legal entities. As stated above one of the main provision of the doctrine of separate legal entity is the limited liability which naturally flows from incorporation of a limited company, this provision allows for the liability of company not to be laid upon the shareholders for any acts or debts of the company. There are provisions within the Companies Act 1985(s.1 (1)) which allows the creation of an unlimited company. There have been time when the concept of separate legal entity has been scrutinized by the courts by lifting the veil of incorporation. The veil of incorporation being lifted is a process under which rights and liabilities of shareholders and the company are held to be the same and the shareholder is held accountable for the debts and liabilities of the company and the separate legal entity vanishes. The courts have normally used the approach when the company is found to be a ‘sham’ or ‘fraud’. Even though this is a device which has been created to find such sham and fraud, this is rarely used. There had been attempts by Court of Appeal to develop what is known as economic reality, however, the House of Lords approached the matter in a traditional manner and restricted such development. In the recent case of Adams v Cape Industries plc the courts stated that veil of incorporation would be lifted if the purpose of formation of company was to conduct a fraud or where it was to avoid an existing obligation. There had been decisions where the courts found parent company to be liable for the debts of its subsidiary but the general principle that has been laid down is that the subsidiary is a separate legal entity and the veil would only be lifted if it is found that parent company had been involved in the management of its subsidiary or acted as its shadow director. Thus if a subsidiary goes into insolvency and the parent is found not to be involved in the management of the subsidiary, the parent would not be held liable. Lord Denning in DHN Food Distributors v Tower Hamlets8 stated that there were certain exceptions to the Salomon principle that is the concept of single economic unit whereby the veil of incorporation may be lifted. This concept merely looks at the separation and running of the management of the company. However, the court ins later case have disregarded such application in later cases (Woolfson v. Strathclyde)9. Further in Adams v Cape Industries the court reject the notion of single economic unit and said that the mere reason for referring to such rules was the fact that there been unawareness of what should be if certain situation arises. It has at time been said that the moralistic approach should not be followed and the veil to be lifted because justice requires such to be done. (Trustor v Smallbone (No. 2)10. The courts have thus resorted to the mala fide test so as to find the exact purpose for which the company was formed. The courts allowed an injunction where the defendant was merely trying to form a company to evade the restraint of trade clause(Gilford Motor Co. Ltd. V Home)11. In Jones v. Lipman12 the courts decided that the company was a ‘facade’ as it had been set up with the intent to defraud creditors. The courts have restricted their application to such type of instances by stating them to be under the head of the ‘fraud exception’.13 The single economic unit principle and the rejection of the idea of holding parent companies to be accountable for the debts of the subsidiary were criticised but that argument by the court of maintaining separate legal entity is clearly well thought of. Even though the doctrine of separate legal entity is well established, there have been times when the courts have resorted to lifting the veil thereby creating uncertainties. However, with time there have been parameters established by the courts which have adjusted the position by identifying the situations under which the veil would be lifted and made the law on corporate personality to be a bit more certain. Thus the current approach of the court to preserve the doctrine of separate legal entity with checks and balances created so as to allow for the veil of incorporation to be lifted have allowed the concept of corporate personality to be a well developed 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