Coporate Law and Limited Liability. There are certain circumstances in which courts will have to look through the corporation, that is, lift the veil of incorporation, otherwise known as piercing the veil, and hold the shareholders of the company directly

Introduction

A corporation under Company law or corporate law is specifically referred to as a "legal person"- as a subject of rights and duties that is capable of owning real property, entering into contracts, and having the ability to sue and be sued in its own name. In other words, a corporation is a juristic person that in most instances is legally treated as a person, and empowered with the attributes to own its own property, execute contracts, as well as ability to sue and be sued.

One of the main motivations for forming a corporation or company is the limited liability it offers its shareholders. By this doctrine (limited liability), a shareholder can only lose only what he or she has contributed as shares to the corporate entity and nothing more.

Nevertheless, there is a major exception to the general concept of limited liability. There are certain circumstances in which courts will have to look through the corporation, that is, lift the veil of incorporation, otherwise known as piercing the veil, and hold the shareholders of the company directly and personally liable for the obligations of the corporation.

The veil doctrine is invoked when shareholders blur the distinction between the corporation and the shareholders. It is worthy of note that although a separate legal entity, a company or corporation can only act through human agents that compose it. As a result, there are two main ways through which a company becomes liable in company or corporate law to wit: through direct liability (for direct infringement) and through secondary liability (for acts of its human agents acting in the course of their employment).

The doctrine of piercing the corporate veil varies from country to country. In the opinion of two Corporate law scholars, apparently, there is a general consensus that the whole area of limited liability, and conversely of piercing the corporate veil, is among the most confusing in corporate law.

Company

Company is an association of a number of individuals for the purpose of carrying on some legitimate business. Generally, company is a form of organization.Organization engaged in business as a proprietorship, partnership, corporation, or other form of enterprise. Originally, a firm made up of a group of people as distinguished from a sole proprietorship. However, since little proprietorship owes their existence exclusively to one person, the term now applies to proprietorships as well.

Shareholders

Shareholder is an owner of shares in a company. Due to the principle of separate legal personality, a shareholder does not own any assets of a company, but rather own shares. The relationship between the shareholders and the company and the rights of shareholders are regulated by the articles of association of the company. The majority of shareholders usually control the company, however exceptions exist for protection of minority shareholders where the majority act oppressively or cause detriment to the minority, or use powers granted in the articles for their personal benefit.

Board of Directors

Directors are the members of a board of directors. Directors must be individuals. Directors can be owners, managers, or any other individual elected by the owners of the business entity. Directors who are owners and/or managers are sometimes referred to as inside directors, insiders or interested directors. Directors who are managers are sometimes referred to as executive directors. Directors who are not owners or managers are sometimes referred to as outside directors, outsiders, disinterested directors, independent directors, or non-executive directors

The Concept of Limited Liability

The main idea behind that the legal personality of a company is separate from that of it's members. The most important ingredient that flows from the separate legal personality clause is that of limited liability. It is aimed at giving investors minimum insurance in their business over their own private lives. Thus, the most a member in the company can lose is the amount paid for the shares themselves and thus the value of his/her investment. Thus, creditors who have claims against the company may look only to the corporate assets for the satisfaction ...

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The Concept of Limited Liability

It is obvious that corporations exist in part, in the first place to shield their shareholders from personal liabilities for the debts of that corporation.

The concepts was invented in the 17th century, and prior to this date, people were scared to invest in companies because any partner in a general partnership could be held responsible for all the debts of the corporation. As the capital needed to finance the largest projects grew, and along with it the necessity of raising money, investors were reluctant to invest because of the risk involved in essentially guaranteeing the entire debt of the business entity.Limited Liability Company (LLC)’s have two major and distinct sets of rights and powers.

In fact, the concept of separate legal personality goes hand in hand with the doctrine of limited liability. The main importance of the limited liability concept is that it protects the company and its members, as well as to facilitate commercial ventures in which the company may be interested. The principle further act to attract and encourage corporate investment, much needed in any society to speed up development. It is believed to be the springboard to raise managerial standards in a corporate organization. It goes without saying that it facilitates better investment strategies by the company question.

Meaning of Corporation in Company Law

To begin with, the word company will be used in this paper to refer to a legal entity with an identity different from that of its owners. It goes without saying that the owners in such an entity are not held liable for the firm's obligations in excess of the value of their investment therein. In fact; a company is equal in law to a natural person.

In different legal systems, corporate law and company law mean the same thing. In either circumstance, the term is used to denote the field of law concerning the creation and regulation of companies or corporations and other business organizations.

The important thing to note however is that although a separate legal entity, a company or corporation can only act through human agents that compose it. As a result, there are two main ways through which a company becomes liable in company or corporate law to wit: through direct liability (for direct infringement) and through secondary liability (for acts of its human agents acting in the course of their employment).

The Veil of Incorporation

Incorporation of a company raises a separate legal liability in the new company, which is distinct from that of the company's directors and shareholders. A company is a separate legal entity from that of its directors and shareholders and therefore has a separate and distinct liability from those directors and shareholders. The operation of this basic legal principle is known as "the corporate veil", because in the event that a company commits a wrong (such as committing a breach of contract), the company is liable for the wrong and not the individual directors and shareholders of the company. Directors and shareholders of companies are therefore insulated from the liability of the company in all but exceptional circumstances, such as fraud and wrongful trading.

A company is distinct from its members or shareholders. A company has a different identity. The 1897 case of Salomon v Salomon & Co Ltd [1897] AC 22 firmly established the principle that a company has a separate legal identity to that of its members. These separate legal identities are protected by the veil of incorporation, which can only be disregarded by the courts in particular circumstances. A company once incorporated becomes a legal personality, separate and distinct from its members and shareholders and capable of having its own rights, duties and obligation and can sue or be sued in its own name. This is commonly referred to as the principle of corporate personality and it carries with it the concept of limited liability. No case illustrated the above principles better than the noted House of Lords decision in Salomon v. Salomon & Co Ltd [1897]. However, in some circumstances, the courts have intervened to disregard or ignore the principle of corporate personality and limited liability. Thus, if a corporation gets sued, only assets of the corporation can be collected to a judgment. If the corporation is insolvent, its debts may go unsatisfied, and creditors are out of luck. They can't go after the assets of those who own the company.

It is this separate legal personality that makes companies an attractive vehicle for commercial ventures, as the liability rests with the company, rather than the shareholders, directors, members or company officers. The separate legal entity forms the basis for limited liability of shareholders. Shareholders' liability is limited to the value of the shares allotted to them. This separate legal personality has the consequence that a company has perpetual succession. Its legal existence survives its shareholders and directors. Its existence is ended when it is wound up pursuant to the Companies Acts.

Example 1: Salomon v Salomon and Co [1897]

Salomon (S) was a sole trading leather merchant. He decided to form a limited company which had seven shareholders (i.e. S, his wife and his five children) each holding one share. As well as a shareholder, S also made himself the managing director of the new company. The newly incorporated company subsequently purchased the sole trading leather business for £39,000. This was partly paid by the further issue of 20,000 £1 shares which S purchased. £10,000 of the purchase price was not paid by the company which instead issued S with a series of debentures (ie written acknowledgements of indebtedness) which were secured against the company assets. At this stage, S was, therefore, the majority shareholder in the company (20,001 shares), the managing director and a debenture holder against the company. The company failed and went into liquidation. S aimed to enforce his debenture and have the company assets sold to repay his £10,000 loan. If this succeeded, the other company creditors would receive nothing. The liquidator, acting on behalf of the other creditors, claimed the other creditors should have priority of payment arguing (1) S and the company was the same person and (2) S should be personally liable for the debts of the company.

The House of Lords ruled that S was not liable for the company debts since the business and debts belonged to the company not S.

Example 2: Macaura v Northern Assurance [1925]

Macaura (M) owned a timber estate, formed a limited company and sold the business to it. Prior to sale, the estate was insured in M’s name. After the sale, M neglected to transfer the insurance policy to the company. The estate was destroyed by fire and M tried to claim under the insurance policy. He was unsuccessful since the damaged assets now belonged to a different ‘person’, i.e. the company not M.

Lifting the Veil of Incorporation

Lifting the veil refers to situations where the courts decide that the separation of the personality of the company and the members should not be maintained. Consider the following example: An Ltd (known as a parent company) owns all the issued share capital in three other companies – X Ltd, Y Ltd and Z Ltd – which in turn are known as wholly owned subsidiaries. Thus, A Ltd controls all three subsidiaries. In economic reality there is just one business but it is organized through four separate legal personalities. This allows the parent company, A Ltd, to gain of limited liability as a shareholder of the other remaining companies. In other words, A Ltd can conduct its risky commercial investments through, for example, X Ltd and if things go wrong, the assets of A Ltd as a shareholder of X Ltd cannot be seized or sold to pay the unpaid creditors. Many consider this unfair and so in certain cases, the courts will ‘lift the veil of incorporation’ between the company and its members, thus treating both as one single entity. In this case, the courts may lift the veil between the company, X Ltd, and its shareholder, A Ltd, and treat both as one single legal personality. Thus, if the risky investment conducted by A Ltd through X Ltd fails, A Ltd may be held liable for any debts incurred.

Example 1 - Jones v Lipman [1962]

Mr Lipman had entered into a contract with Mr Jones for the sale of land. Mr Lipman then changed his mind and did not want to complete the sale. He formed a company and in an attempt to avoid the transaction, sold the land to the company. Lipman then claimed that he could not complete the transaction with Mr Jones since he no longer owned the land, i.e. the company was now the lawful owner. The court lifted the veil of incorporation – ruling that the company was but a façade – and ordered Lipman to conclude the transaction with Mr Jones.

1966-1989: Known as the interventionist years when the courts demonstrated that they were much more willing to lift the veil of incorporation.

Example 2 - Gilford Motor Co Ltd v Horne [1933]

An employee (Mr Horne) promised that after the termination of his employment he would not solicit his former employer’s customers. After the termination of his employment contract, Horne formed a company which issued circulars to clients of his former employer. Horne argued that it was the company (as a separate legal personality) that was attracting the clients – not him. The court lifted the veil and issued an injunction preventing the further distribution of the circulars on the grounds that the company was merely a ‘front’ for Horne.

Criticism:

There is some criticism of the company as a separate legal entity, those are following:

Ever since the House of Lords handed down its decision in Salomon's case, legal doctrine regards each company as a separate legal entity. When coupled with the consequent attribute of limited liability, the Salomon principle provides an ideal vehicle for fraud. Because of its malleability and facility for protecting directors and members against the claims of creditors, the corporate form has been responsible for the development of many different forms of fraudulent or anti-social activity. Fraud, in this context, cannot be precisely defined, but two tangible illustrations may elucidate the concept.
Limited liability attracts small traders to the corporate form not because it represents an effective device with which to raise capital, but because it gives them access to an avenue via which to escape the "tyranny of unlimited liability". Criticisms of limited liability are addressed at its impact on creditors and on society at large. The principle is that a limited company's creditors must look at the capital, the limited fund, and that only. Limited liability discourages shareholders from monitoring and controlling their company's commercial ventures. The company's creditors bear the burden of the risks inherent in dealing with limited liability companies. At issue is whether it is right that limited liability should operate to restrict the size of the company's capital. Different types of creditors have different capacities to protect themselves against these risks. While banks and similar financial creditors easily overcome such risks, the same cannot be said of trade creditors, employees and tort creditors. Because trade creditors rarely insist on security before they supply goods on credit, they bear a considerable part of the risk of corporate insolvency. Employees are in an even more precarious position. In stark contrast to finance and trade creditors, employees have no opportunity to obtain security or diversify the risk of their corporate employer's insolvency. Moreover, the majority of employees have minimal information about their employer's financial standing. While contract creditors bear a degree of risk when they deal with a limited liability company, they at least enter into the contract by their own will. This is not so for a company's tort creditors. Victims of torts committed by a company bear an uncompensated risk in case of the company's insolvency.

Conclusion

The act of piercing the corporate veil until now remains one of the most controversial subjects in corporate law, and it would continue to remain so, even for the years to come. By and large, as discussed in the essay, the doctrine of piercing the corporate veil remains only an exceptional act orchestrated by courts of law. Courts are most prepared to respect the rule of corporate personality, that a company is a separate legal entity from it's shareholders, having it' own rights and duties, and can sue and be sued in it's own name.

As we move from jurisdiction to jurisdiction across the globe, it's application narrows down to how that system of the law appreciates the subject. Common law jurisdictions are examples par excellence where the piercing of the corporate veil has gained notoriety, and as the various cases indicate, courts under this system of the law generally appreciates every case by it's merits.

Bibliography

Arun Kumar Sen and Jitendra Kumar Mitra, Commercial law and Industrial Law [ business law] 26th edition
Dr. M. Zahir, Company and Securities Laws.
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