In the eyes of the law, once registered, a company has its own legal identity separate from its members. Case study

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In the eyes of the law, once registered, a company has its own legal identity separate from its members. This has been the case since businesses started to become incorporated. However, it was not until the case of Salomon v Salomon & Co Ltd [1897] A.C. 22), that this was recognised by the court and became the case law which introduced the phrase the veil of incorporation between a company and its shareholders, acting as a screen between them.

In 1892 Salomon formed a limited company to take over his business as leather merchant and boot manufacturer. Each member of his family, wife, daughter and four sons, signed the memorandum of association and subscribed for one share each. Salomon was paid in 20,000 shares of £1, a £10,000 debenture, secured by a floating charge on the company’s assets and the balance, up to £39,000, in cash. Unfortunately the business went into liquidation within one year. The assets were sufficient to pay off Salomon’s debentures but all trade creditors would receive nothing. This was challenged by the unsecured creditors, claiming the company was an alias or agent of Salomon. The House of Lords held that as Salomon & Co Ltd was a separate and distinct person from Salomon then the debentures were valid and the remaining creditors of the new company should have been aware of the risk they were taking. (Keenan & Bisacre 1996 p3).

This firmly establishes an incorporated company as a separate legal identity from its shareholders. The recognition of separate personality led to a number of consequences as shown below:

Company Property

As a separate entity a company can own property and assets. The property does not belong to shareholders. In Macaura v Northern Assurance Co Ltd [1925] A.C. 619, it was established that a shareholder does not have insurable interest in a company’s property. Macaura should not have effected an insurance policy on the timber in his own name, but in the name of the company as a separate entity. However, Westminster Fire Office v Glasgow Provident Investment Society (1888) 13 App Cas 699 had previously made it possible for a debenture holder to insure property up to the value of the loan as he has an insurable interest in the company’s property, unlike a shareholder.
Salomon was also used to distinguish wholly owned subsidiaries as separate entities and not agents of the holding company or each other. This was established in Multinational Gas and Petrochemical Co v Multinational Gas and Petrochemical Services Ltd [1983] All ER 563.

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Company Contracts

Not only are shareholders distinct from a company but so are its employees, no matter how few. In Lee (Catherine) v Lee’s Air Farming Ltd [1960] 3 All ER 420, Mrs Lee was seeking compensation, under the New Zealand Workers’ Compensation Act 1922, from Lee’s Air Farming Ltd for the death of her husband whilst on company business. The issue that needed to be clarified was whether a relationship existed between a company, as an employer and a single employee. Using Salomon, it was held that this relationship did exist and compensation was due.

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Company Contracts

Not only are shareholders distinct from a company but so are its employees, no matter how few. In Lee (Catherine) v Lee’s Air Farming Ltd [1960] 3 All ER 420, Mrs Lee was seeking compensation, under the New Zealand Workers’ Compensation Act 1922, from Lee’s Air Farming Ltd for the death of her husband whilst on company business. The issue that needed to be clarified was whether a relationship existed between a company, as an employer and a single employee. Using Salomon, it was held that this relationship did exist and compensation was due.

Criminal Liability

Macaura establish that a company can own property and assets. This applies even if there is only one principle shareholder. It follows that a controlling shareholder-director may commit the criminal act of theft against ‘his’ company. (Inland Revenue INS48305). This was successfully proven in R v Philippou (1989) 5 BCC 665.

Limited Liability

One of the main benefits following Salomon is the acknowledgment of limited liability. However, this liability does not reflect on the company but on it’s’ shareholders. As it is the company that has the debts it is the company’s responsibility to honour them. Provided a members share is fully paid up then the amount already invested is the limit of their liability. The limit of liability can be found in the memorandum of association of a limited company.

Perpetual Succession

The rule of Perpetual Succession allows for the existence of a company even though there are no members. This means that even though a member dies, goes bankrupt, or retires from the company by transferring shares, the company carries on and is not dissolved. (Keenan and Bisacre p2).

Borrowing

A company has both implied or express powers to borrow and can give security for the loan and pay interest. General Auction Estate and Monetary Co v Smith [1891] 3 Ch 432 gives a company implied powers to borrow providing this is incidental to its objects. However, it is also common to provide express powers in a company’s memorandum, often imposing a limit on the amount of borrowing permitted. It should be noted that for a public limited company an s.117 (of the Companies Act 1985) certificate is required and it cannot borrow or raise capital until issued.

Despite these principles of separate personality, there are certain situations where the Courts have shown themselves willing to "lift the veil of incorporation" and ignore or set aside the separate legal personality of a company.

The veil may be lifted by the courts or through statute. The Courts will not allow the corporate form to be used;

for the purposes of fraud or dishonestly
as a device or sham to evade contractual or other legal obligation
as a façade to conceal the true facts
where it is established that there has been dishonesty or abuse of the corporate form
where employees are seeking to avoid responsibility or are carrying out illegal activities.

In Gilford Motors v Horne [1933] Ch 935 the issue of “sharp practice” or “sham” was addressed. Horne set up a company in competition with Gilford Motors. He was however, as an individual, bound by a restraint of trade. It was held that Horne’s company was a mere cloak and he was prevented from soliciting trade from Gilford Motors.

The courts have also ruled that once a contract has been entered into it must be met. This was determined in Jones v Lipman [1962] 1 WLR 832. Mr Lipman agreed to sell land to Mr Jones, but then changed his mind. In an attempt to defeat Mr Jones’ right to specific performance, Mr Lipman formed a company and transferred the land to it. The court disregarded the principle that a company is separate from its shareholders and ordered that Mr Lipman and the company should sell the land and honour the contract.

Despite the Multinational Gas case the courts have also lifted the veil to allow a group of companies to be seen as one. Lord Denning in DHN Food Distributors v London Borough of Tower Hamlets [1976] 3 All ER 462 concluded that if a group of companies is required under company law to submit joint accounts then the judiciary should recognise a group entity. Tower hamlets were seeking to compulsory purchase land from a subsidiary of DHN and was willing to pay compensation. However, a second subsidiary owned the premises on the land. Tower Hamlets refused to pay compensation for the premises arguing that the second company had no interest in the land. The loss of land would lead to a loss of premises and also force all three companies into liquidation. Tower Hamlets became liable to compensation for the loss of the business.

Adams v Cape Industries [1990] Ch 433 extended the principle in Salomon to cover a group of companies recognising that even though no agency agreement exists between subsidiaries transactions entered into by a subsidiary could be regarded as those of the holding company. This principle has recently been reaffirmed in Ord & Another v Belhaven Pubs Limited [1998] BCC 607. In Smith, Stone & Knight Ltd v Birmingham Corporation (1939) 4 All ER 116 27, the court addressed the principle of presumed agency and questioned whether a particular subsidiary company was carrying on the parent company’s business or its own. The court decided that as the directors were the same in both companies they were seen as owner occupiers and entitled to compensation.

In addition to case law statutes can be used to lift the veil of incorporation and remedy and wrongdoing. In the main these are;

s.349 (4) Companies Act 1985 – this requires the company name to appear on bills of exchange, cheques, promissory notes, endorsements, money orders and goods orders. This is to ensure that those who deal with the company are aware that it is the company and not an individual with whom they contract. Failure to ensure this could result in the officer of the company who authorises the dealing personally liable for the amount with the possibility of being fined.
s.227 Companies Act 1985 – this section establishes the duty of a group of companies to prepare not only individual accounts but also group accounts.
s.213 and 214 Insolvency Act 1985 – during the winding up of a company any director committing fraudulent or wrongful trading may be liable to make personal contributions to creditors. The liquidator can also bring an action for wrongful trading, where the company’s trade was continued when the directors were aware that the company was insolvent and could not meet its forthcoming liabilities. (Impey and Montague1991 p110).
s.15 Company Directors Disqualification Act 1985 – if an individual acts as a director of a company whilst disqualified and/or an undischarged bankrupt, or if someone involved in the management of a company acts, or is willing to act, for an individual they know to be disqualified then they are personally responsible for such debts that may arise.

The recognition of a company as a separate legal entity and the creation of “the veil of incorporation” were extremely consequential. Over time the Salomon case was used as the basis for recognising property ownership and the capacity to contract. It also establishes limited liability of shareholders, the rights of a company to borrow money and the fact that through perpetual succession, a company can exist ad infinitum. Nonetheless, a company cannot operate without people. On occasion individuals have sought to use the veil to conduct improper and unlawful business. Through the judiciary and statute the courts have demonstrated that, where necessary this veil will be lifted and the appropriate remedies sanctioned.

References;

French, D. (2003) Blackstone’s Statutes on Company Law 2003-2004 7th ed. Oxford University Press.

Impey, D., Montague N. (1991) Running A Limited Company Jordan & Sons Ltd.

Keenan, D., Biscare J. (1996) Smith and Keenan’s Company Law for Students Pitman Publishing

Registration, Liability and the Veil of Incorporation. Semple Piggot Rochez. Found at (08 01 2004)

Companies Act 1985

Company Directors Disqualification Act 1985

Insolvency Act 1985

Websites used;

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