There is a very unique relationship between an 'Incorporated Company' and its Directors

Re-enforcing the principle that a company has its own legal identity is the case of Macaura. In this case, involving a man who transferred property from his name into his new “company name”, Mr Macaura lost most off the timber due to a fire but when he tried to claim from his insurance they refused and argued that Mr Macaura had no insurable interest in the property and therefore could not insure it i.e. the company should have insured it in the company’s name. The House of Lords decided that the timber belonged to the company and not Mr Macaura. They also found that Mr Macaura, although he had all the shares, had no insurable interest in the property of the company and finally that just as corporate personality facilitates limited liability by having debts belong to the corporation and not the members, it also means that the company’s assets belong to it and not to the shareholders. Limited liability is the logical consequence of the existence of a separate personality. After the landmark case of Salomon v Salomon the law now recognises that a company can sue and be sued in its own name, hold its own property and be liable for its own debts. It is this concept that enables limited liability for members/shareholders to occur as the debts belong to the legal entity of the company and not to the shareholders in that company. The shareholders will lose their initial investment in the company but they will not be responsible for the debt of the company.

If a Company is responsible for its own debts, who is responsible for running up those debts? In law a company is its own legal entity but in reality a ‘Company’ cannot place an order or perform a service therefore the directors, which are placed in charge of running the Company for all the shareholders, have a fiduciary obligation towards the ‘Company.’ Every private company must have at least one director according to s. 282 of the Companies Act 1985.  Whether someone, acting as an agent for the company, has actual authority or apparent authority does not matter due to contract law and the fact that the other party may rely on that representation thereby binding the company. The directors’ fiduciary duties are to act in good faith and in the best interests of the company, to act for the proper purpose, not to make secret profits and to avoid conflicts of interest. In a recent case the Court of Appeal held that a director owed a duty to confess his own misconduct to the company. This case is a good example of how much trust is put in a director. Directors owe these duties to the company, not to shareholders, unless there is a special factual relationship between them that generates a fiduciary obligation.  In two separate cases, Hoffman LJ accepted that the common law test of a director’s duty of care is the same as that stated in s. 241(4) of the Insolvency Act 1986. Directors are required to act bona fide in the interests of the company. In the case of Hogg v Cramphorn Ltd, which concerned an allotment of shares to prevent a takeover, it was held that although the fiduciary duty of allotting shares was done by the directors with the best interests of the company at heart, the shares were issued for the wrong purpose and therefore it was a breach of their fiduciary duties to the Company. As well as having common law duties and fiduciary duties, directors also have statutory duties to fulfil. However, these statutory duties are mainly procedural in nature. The provision in s. 310 of the Companies Act 1985 generally prohibits UK companies from indemnifying their directors or advancing costs. This has been replaced by the Companies (Audit, Investigations and Community Enterprise) Act 2004 which has updated it and allowed for some exceptions. If directors act fraudulently, illegally or with oppression, the courts may ‘lift the veil of incorporation.’ The Salomon case, with its principle of a company’s debts belonging to the company and not the shareholders even though Mr Salomon was in essence a ‘sole trader’, allows for a lot of fraud on the part of the directors. Generally the court will not lift the veil to impose liability upon a shareholder for the company’s debts, nor will they lift the veil to benefit a shareholder who has discovered that trading as a company is a disadvantage. The courts, in determining whether or not to lift the veil, take into consideration the substance rather than the form of an agreement or arrangement. Not only the courts but the legislature has also always been concerned with minimising the extent to which the Salomon principle could be used as an instrument of fraud. As a result it introduced the offence of fraudulent trading now contained in Section 213 of the Insolvency Act 1986. The requirement to prove ‘intent to defraud’ became too difficult in practice because of the possibility of a criminal offence arising and so the lesser offence of ‘wrongful trading’ was introduced in order to provide a remedy where Directors have behaved negligently rather than fraudulently. Thus if a Director continued to trade in circumstances where a reasonable director would have stopped, the director concerned will be liable to contribute to the company’s debts under section 214.

The company laws of all economically advanced countries make available vehicles through which businesses can be carried on with the benefit of limited liability for their shareholders. There is a disparity between the risks and rewards which shareholder have but the concept of ‘limited liability’ facilitates investments from members of the public which is of great importance to the economy. Limited liability works well for the investor and the economy but the veil of incorporation is not fixed. It can be lifted to prevent fraud and illegal practices. The woriginal purpose of limited liability was to enable passive investors to put a limited sum of money into a business, not for what is effectively a sole-trader using the incorporation to limit his liability. That is why there are so many checks and balances and why directors have duties placed upon them to protect the other members, employees and creditors. Without fiduciary duties and common law duties, limited companies would not be as good an investment as it is today. The law with regards to companies and directors of those companies is always changing and becoming more certain. For example the fiduciary duty of ‘good faith’ has long been equated with honesty although a recent employment law case seems to suggest that honesty is not enough and some purity of motive is required. All these duties and procedures all add up to provide a strong and structured approach to resolving disputes between the shareholders in a company which in turn makes incorporating a small business more attractive. As for the future of Company Law, on the 17th of March 2005 the Department of Trade and Industry published a White Paper setting out its proposals for a Company Law reform Bill. It is proposed that the Bill will include provisions to codify the duties of directors, require that at least one director be a natural person and the bill will remove the restrictions on directors over 70 years old and provides that the minimum age for a director be 16.

So, considering the nature of limited liability, it is not at all baffling that directors of companies have onerous fiduciary and statutory duties forced upon them because as Lord Acton stated, “Power tends to corrupts; absolute power corrupts absolutely.” It has become clear to me that the only faulty link in the chain of company control and regulation is the human mind. The duties are in place to protect the members of a Company from themselves.