Separate Legal Personality of a Company

In Gilbert and Sullivan’s ‘Utopia’, the concept of a limited company is described, rather poetically:

“Some seven men form an Association (If possible, all Peers and Baronets), The start off with a public declaration To what extent they mean to pay their debts. That’s called their Capital; if they are wary They will not quote it at a sum immense. The figure’s immaterial–it may vary From eighteen million down to eighteenpence. I should put it rather low; The good sense of doing so Will be evident at once to any debtor. When it’s left to you to say What amount you mean to pay, Why, the lower you can put it at, the better…

They then proceed to trade with all who’ll trust ’em Quite irrespective of their capital (It’s shady, but it’s sanctified by custom); Bank, Railway, Loan, or Panama Canal. You can’t embark on trading too tremendous– It’s strictly fair, and based on common sense– If you succeed, your profits are stupendous– And if you fail, pop goes your eighteenpence”.

How does the concept of separate legal personality and limited liability give rise to the circumstances Gilbert and Sullivan describe? Does you think that the law goes far enough in disregarding, or avoiding the consequences of, separate legal personality, when justice requires it to do so? This article explains further.

An incorporated company, “united or combined into an organised body”, is recognised by law as a separate legal entity, or ‘legal person’ distinct from the separate personalities of the members of the body. The law treats it like “any other independent person” having rights and liabilities. A company, as a legal person, may enter into contracts, own property and even commit crimes. It is this concept of the Company being a fictitious person (then under the ‘Stock Company Act’ ) ‘Utopia’ ridicules, where Gilbert, in his libretto, toys with the idea that there could be a convergence of natural persons and legal entities.

Where a private company limited by shares owes money, and becomes insolvent, the law holds that since its creditors dealt with the Company – not its individual members – regardless of “the ideas or schemes of those who brought it into existence”, the extent of financial liability of its members is limited to the amount the members agree to pay for their shares: their “public declaration.. to what extent they mean to pay their debts”. Gilbert’s words satirize the consequences of this: if the Company becomes insolvent, the creditors do not get paid, regardless of the personal financial situations of its members. This can be contrasted with a partnership or sole proprietorship, where the owner would be held responsible for all debts of the corporation.

Conversely, where a company owns assets, those assets belong to the Company, not its members: in contrast with a partnership or sole proprietorship, where the owner(s) of the assets are the partners or the proprietor. Members cannot claim an interest as the assets were purchased by the Company, as legal owner which, as in Macaura can be to the detriment of the member.

On occasions, the law is prepared to circumvent the usual consequences of legal personality by ‘lifting’ or ‘piercing’ the veil of incorporation – for example, where a company’s shareholders are using the Company as a device to avoid their responsibilities. In Jones v Lipman, Lipman transferred a property to his company, to avoid having to transfer the property to Jones. The Court held the Company was a “device and a sham, a mask which [Lipman] holds before his face in an attempt to avoid recognition by the eye of equity”.

This does not mean that the Courts will always lift the corporate veil wherever justice requires it. The Courts have vigorously fought against any attempt to allow anyone, let alone themselves, “peer under the skirts of a company”. In Adams v Cape Industries, a company that marketed asbestos set up subsidiaries so that if a customer sued for asbestos-related claims, only the subsidiary would be liable. The bankruptcy of a subsidiary would not affect Cape. The Court held that Cape were entitled to “organise affairs.. so that it would have the… benefit of the group’s asbestos trade in the USA without the risks of tortuous liability”.

Similarly, in Ord and another v Belhaven Pubs Limited a defendant company that was not trading, transferred all of its assets to other companies in its group, and consequently claimants attempted to sue those other companies for the debt the defendant owed. The court dismissed the claim, stating that the transactions were overt and “conducted in accordance with the liberties conferred upon corporate entities by the Companies Act”.

In recent times, the approach would seem to be that the Court will go to any length to avoid any obvious penetration of the corporate veil. In Allen v Amalgamated Construction Co Ltd the European Court of Justice examined the workings of a company to investigate whether transfers between subsidiaries were capable of being a transfer under the TUPE regulations. Similarly, in Pirelli Cable Holding NV v IRC the Court, whilst denying that it was lifting the veil, “availed itself of a jolly good rummage around the internal workings” in order to examine certain facts.

The Courts have on occasion held directors personally liable for their actions. In C Evans & Sons Limited v Spritebrand Ltd, the Court held that, in every case it is necessary to examine with care what part the director played personally with regards to the act complained of. The Court declined the opportunity to formulate a comprehensive definition of circumstances that would always give rise to liability.

More recently, in MCA Records Inc, whilst not setting out general principles, the Court held that per CBS Songs Ltd and Unilever plc v Gilette (UK) Ltd, liability may arise where the individual ‘intends and procures and shares a common design that an infringement takes place’. Consequently, these cases establish that directors can sometimes be personally liable for torts for which the company is also liable. Still, the Courts have retained the principles of separate legal personality and limited liability, and defended the protection they offer. Whilst permitting some ‘rummaging’ under the veil to establish facts, they have severely limited any encroachment on those principles.

We have seen how the principles of separate legal personality and limited liability sometimes result in circumstances that may seem favourable to the Company’s shareholders and detrimental to its creditors. On one hand, there are good reasons for retaining these principles. The Courts feel that to subject individual shareholders or directors to onerous personal liabilities would discourage commercial enterprise. Additionally, whilst creditors are exposed to risk, they are fully aware of this risk: the Company’s Memorandum, a public document, freely states that the company is limited by shares, the liability of its members is limited, and by how much. So when the Company “proceed[s] to trade with all who’ll trust ’em”, the risk creditors take is easily calculable.

On the other hand, there are cases where, if it were not for company law, other principles would require the Courts find individual members liable for their debts and actions. Cases such as Adams v Cape Industries, where members have deliberately arranged their affairs to avoid liability if sued, are difficult to correlate with equitable principles of justice. The law is moving towards introducing provisions to prevent members abusing the principles to avoid liability for serious crimes and should go further to introduce provisions preventing the avoidance of liability for serious losses.

Materials referred to:

Payne, J, MA (1998) Lifting the Corporate Veil, Company Law Gilbert, W S – Utopia, Limited Halsbury’s Laws of England from LexisNexis – Corporations (Volume 9(2) (2006 Reissue) Halsbury’s Laws of England from LexisNexis – Companies (Volume 7(1) (2004 Reissue) Hill, C, Hubble, P, Longshaw, A, Morgan, T & Roberts, S (2007) W223 Company Law and Practice, Oxford University Press, Oxford New Law Journal from LexisNexis – von Wachter, V (13 July 2007) The Corporate Veil, 157 NLJ 990 New Law Journal from LexisNexis – Pedley, P (6 May 2005) Hints for hungry litigators, 155 NLJ 702

CASES:

Adams v Cape Industries (1990) Ch 433
Allen v Amalgamated Construction Co Ltd: C-234/98 [1999] ECR I-8643, [2000] All ER (EC) 97
Jones v Lipman (1962) 1 All ER 442
Macaura v Northern Assurance Co Ltd (1925) AC 619 Ord and another v Belhaven Pubs Limited (1998) BCC 607
Salomon v A Salmon and Co Ltd (1897) Ac 22 [1895-99] All ER Rep 33