Limited Liability, and effect on contract and tort creditors.

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Company Law

Question 2

In a corporate group every company in the group is a separate legal entity to the other companies which are within the group. This was established through Salomon’s case, through incorporation a company has limited liability. In Salomon’s case the House of Lords found that “a person may sell a business to a limited liability company of which the person is virtually the only shareholder and director. The company was a separate legal entity distinct from its shareholders and directors”. The incorporation of a company whether it is owned by one man or a group of shareholders would not change the fact that creditors are dealing with a company with limited liability. Corporate groups as a result of the Salomon’s principle indicate that creditors can only claim against the company in which the debt is against and can not be enforced against the parent company. Limited liability is known as the corporate veil which means companies have limited liability. But this corporate veil might be lifted in certain instances so the parent company becomes liable for the subsidiary’s debts. Under section 588V of the corporations act indicates that a holding company becomes liable when it incurs the debt, becomes insolvent through incurring the debt and there are grounds for suspected the company is insolvent or is to become insolvent.

Advantages of Limited Liability, and effect on contract and tort creditors.

Through having limited liability for companies in a corporate group there are many advantages which encourage this form of structure to take place. Salomon’s principle for a company in a corporate group to have limited liability give the holding company an ability to maintain control in a subsidiary and gives it an advantage of taking calculated risks to improve shareholders wealth. By lifting the corporate veil and making the parent company liable for the debts associated with the subsidiary makes it hard for diverse investments and risk taking which has manifested itself with this sort of business practice. If the holding company becomes liable for the dealings of the subsidiary it makes structure of the corporate groups volatile. Because the individual dealings of a subsidiary are not directly controlled by the holding company, especially in relation to tort creditors. But indirectly a holding company has control because they have a majority shareholding and usually have directors on the board representing the holding company.

The dangers of having the holding company liable for actions of the subsidiary would see the collapse of the whole corporate structure. Because if the debts incurred by the subsidiary are substantial and they are unable to pay the holding company would then be expected to fill the void. The hazard “would not arise from the liquidation, but rather from the tortuous injuries caused by the subsidiary”.This places in risk the holding companies shareholders and all the shareholders linked to the corporate group. Hence there will be no benefit in having takeovers and creating a controlling stake in companies if limited liability is not enforced.

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Limited Liability for contract creditors when dealing with the subsidiary will mostly be the same. For the majority of contract creditors it is expected that the creditor has dealt with due diligence and care prior to entering in to the contract. Limited liability for the subsidiary would mean that the contract is only with the subsidiary and not with the holding company. If limited liability was not enforced it would enable contract creditors to exploit the holding company when they themselves did not express the due care. In Pioneer Concrete Services Ltd v Yelnah Pty Ltd it was held ...

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