Company Law and Separate Legal Personality

Company Law and Separate Legal Personality (SLP)

Introduction

  • When a company is formed, it is operated by a few individuals, but company law creates a legal separation between the company and its operators.
  • Shareholders are distinct from the company, which is recognized as a separate entity with its own existence.
  • The company structure is used for legitimate purposes like:
    • Entering into contracts.
    • Owning property.

Obtaining Separate Legal Personality

  • A company gains separate legal personality upon registration under the Companies Act 2006.
  • The process of registration is called incorporation.
  • Incorporation grants the company an independent personality.

Implications of SLP

  • A registered company (e.g., ABC Limited) and its shareholders are separate entities.
  • Rights of a Company with SLP:
    • The ability to sue in its own name (e.g., ABC Limited vs. someone).
    • The ability to be sued.
    • Owning property.
    • Entering into contracts.
    • Exercising legal rights like an individual.

The Corporate Veil

  • The separateness between a company and its shareholders is termed the corporate veil or veil of incorporation.

  • Example:

    • If a company becomes insolvent (unable to pay its debts), creditors can only sue the company, not the shareholders.
    • The separate legal personality protects shareholders from being directly liable for the company's debts.

Registration and Limited Liability

  • The process starts with registering the company under the Companies Act.
  • This registration provides separate legal personality.
  • In insolvency, creditors can only claim against the company, not the shareholders, due to the veil of incorporation.
  • Shareholders have limited liability, restricted to the amount they invested in the company.
  • Sole proprietorships and partnerships do not have this artificial existence or veil of incorporation.
  • Without the veil, shareholders would be liable for the company's debts.

Historical Context

  • The Joint Stock Companies Act of 1844 established procedures for modern company law.
  • Registration is required to be recognized as a company and to achieve limited liability.

Abuse of SLP and Landmark Case: Salomon vs. Salomon

  • Some individuals abuse separate legal personality by forming a company, using its name to acquire funds, and then failing to repay, knowing creditors can only sue the company.
  • The case of Salomon versus Salomon is a key example.
Facts of Salomon vs. Salomon
  • Aaron Salomon, a leather merchant, formed Salomon Co. Limited to expand his business.
  • At the time, seven shareholders were required.
  • Salomon allocated 20,000 shares to himself and one share each to his wife and family members.
  • The company borrowed money from banks and financial institutions.
  • The business failed, and the company could not pay its creditors.
  • A liquidator was appointed to manage assets and distribute funds to creditors.
  • Creditors wanted to sue Salomon directly, claiming he was the majority shareholder.
Court Decisions
  • High Court: Ruled that the shareholders were nominees of Salomon and had committed fraud, making Salomon responsible for the company's debts.
  • Court of Appeal: Agreed with the High Court, stating that while a company has separate legal personality upon registration, Salomon had perpetrated fraud by involving family members as shareholders.
    • The court decided the corporate veil should be lifted, making Salomon liable.
  • House of Lords: Overturned the previous decisions, questioning the validity of the company's formation. Since the company was validly formed with the required seven shareholders, SLP applied.
    • The House of Lords emphasized that creditors could only sue the company, not the shareholders.
Rationale for Decisions
  • The High Court and Court of Appeal believed Salomon defrauded creditors, justifying the removal of the corporate veil.
  • The House of Lords strictly followed the law, regardless of the motive behind incorporation, as long as registration was valid.
  • The Court of Appeal feared the dangers of separate legal personality, which could lead to abuse.
  • They were willing to pierce the corporate veil, holding Salomon responsible and considering the commercial reality.
  • Lord Lee highlighted that Salomon's liability should depend on the purpose and manner of forming the company.
  • The House of Lords reaffirmed that a company is a distinct legal entity from its members.
  • The House of Lords focused on whether the Companies Act was followed, affirming that once a company is validly formed, the protections of the Act apply.
Policy Considerations
  • The House of Lords' decision took into account policy considerations.
    • If Salomon were held liable, it could discourage investors by making them vulnerable to company debts.
  • The decision supports the principle that owning all or most of the company's shares does not negate SLP.
  • Lord McNaughton stated that a company is a separate legal person from its shareholders, and this separateness is embedded in English company law.
Malaysian Position
  • Malaysia also applies SLP, with Salomon versus Salomon being influential.
  • Malaysian companies gain separate legal personality upon registration.

Effects of Salomon vs. Salomon

  • If a company is validly incorporated, courts are reluctant to disregard the shareholder's personal denial by lifting the corporate veil.
  • There is a complete separation between the company and its members.
  • In insolvency, creditors can only sue the company, not the shareholders.
  • Shareholders risk only their investment, not being unconditionally liable for company debts.

Advantages of Affirming SLP and Limited Liability

  • Encourages Investment:
    • People are more likely to invest because their risk is limited to their investment.
    • Personal assets are protected by the veil of incorporation.
  • Encourages Risk Taking by Directors:
    • Directors are more willing to pursue ventures and expansions, knowing the shareholders risk is limited.
  • Disadvantages for Creditors:
    • Creditors may end up with nothing if the company is insolvent.
    • Creditors must monitor and protect against risk effectively, often requiring personal guarantees from directors or board representation.

Other Landmark Cases: Macaura vs. Northern Assurance Co.

  • Macaura vs. Northern Assurance Co. supports SLP.
Facts of Macaura vs. Northern Assurance Co.
  • Macaura owned an estate and formed a company where he was the majority shareholder.
  • He bought a timber estate under the company's name and insured it.
  • After a fire destroyed the timber, the insurance claim was denied because Macaura was not the owner of the timber estate.
Court Decision
  • The court upheld that even as a majority shareholder, Macaura and the company are separate legal entities.
  • The property of the company belongs to the company, not its shareholders.
  • The fact that a person holds substantially all the shares does not make the company's business that person's business.
Other Cases
  • Lee vs. Lee is another relevant case for studying SLP.

Exceptions to the Salomon Principle: Piercing the Corporate Veil

  • Exceptions were developed to address abuses of SLP, allowing the corporate veil to be lifted.
  • Lifting the veil means shareholders and directors can become personally liable for the company's debts.
  • Some exceptions are created by statute, while others originate from common law.
  • It is essential to strike a balance. Too many exceptions could undermine the protection offered by companies acts.

Instances of Piercing the Corporate Veil (Common Law)

  • Fraud:
    • If shareholders are found defaulting creditors, the veil can be lifted.
    • The difficulty lies in proving fraud.
  • Interest of Justice:
    • The court may lift the veil in the interest of justice.
    • This is often based on the judge's discretion and lacks clear guidelines.
  • Single Economic Unit Argument:
    • This applies to a group of companies (parent and subsidiaries).
    • The question is whether to treat the group as a single economic unit or as separate entities.
    • If treated as a single unit, debts of the parent company can be claimed from the subsidiaries (piercing the veil).
    • In newspapers it is written parent and subsidiary. So the Facebook Publication and University can be described in that way. But in legal setting, it is parent-subsidiary relationship.