Company Law A - Separate Legal Personality

Company Law: Separate Legal Personality

• Generally, a company exists only if there is at least one share, according to the Companies Act 1993 (CA 93), s 10(a).

• The court must generally treat a company and its shareholders as separate legal entities (CA 93, ss 15 and 97; Salomon v A Salomon & Co Ltd).

• A third party dealing with a company typically has a claim against the company only, even if a shareholder is involved in the business (CA 93, ss 15 and 97; Salomon v Salomon & Co Ltd).

• The third party's claim remains solely against the company, even if the shareholder effectively controls the company's business (Lee v Lee’s Air Farming [1961] NZLR 325 (PC)).

• A shareholder does not have a special right to treat company assets as their own (Macaura v Northern Assurance Co [1925] AC 619 (HL)).

• However, a court may treat a company and shareholder as the same person if the shareholder uses the company as a "cloak or sham" (Gilford Motor Co Ltd v Horne (CA); Prest v Petrodel Resources Ltd (SC)).

• In such cases, a third party may have a claim against the shareholder if the shareholder uses the company to:

  • Conceal the fact that the company's business is effectively being carried on by the shareholder (lifting the corporate veil).

  • Evade some liability that the shareholder has (piercing the corporate veil).

• The court may pierce the corporate veil only if it's the only way to remedy the harm suffered by the plaintiff (Prest v Petrodel Resources Ltd).

Essential Requirements of a Company (CA 93, s 10)

• A company must have:

  • A name.

  • One or more shares.

  • One or more shareholders with limited or unlimited liability.

  • One or more directors, with at least one living in New Zealand or an enforcement country (like Australia).

• For the class, the most important requirement is that the company have one or more shares.

• A share can be seen as a type of loan from the holder to the company.

• CA 93, s 36(1) outlines the rights a share confers on its holder:

  • The right to one vote on a poll at a company meeting on any resolution, including to:

    • Appoint or remove a director or auditor.

    • Adopt a constitution.

    • Alter the company’s constitution.

    • Approve a major transaction.

    • Approve an amalgamation of the company.

    • Put the company into liquidation.

  • The right to an equal share in authorized dividends.

  • The right to an equal share in the distribution of surplus assets.

• The law recognizes the concept of a "company to be".

• CA 93, s 182(1) to (3) addresses pre-incorporation contracts:

  • A pre-incorporation contract is one made by a company before its incorporation or by a person on behalf of a company before and in contemplation of its incorporation.

  • Such a contract can be ratified within a specified period or, if no period is specified, within a reasonable time after the company's incorporation.

  • A ratified contract is as valid and enforceable as if the company had been a party to it when it was made.

Separate Legal Personality (CA 93, s 15)

• A company is a legal entity separate from its shareholders.

• The company continues in existence until it is removed from the New Zealand register.

Liability of Shareholders (CA 93, s 97)

• Shareholders are generally not liable for a company's obligations simply by being a shareholder unless the company's constitution states otherwise.

• A shareholder's liability to the company is limited to:

  • Any amount unpaid on a share held by the shareholder.

  • Any liability expressly provided for in the company's constitution.

  • Certain liabilities arising by reason of certain provisions.

  • Any liability to repay a distribution received by the shareholder to the extent that the distribution is recoverable.

  • Any liability under certain provisions.

• This section does not affect a shareholder's liability to a company under a contract, or for any tort, breach of fiduciary duty, or other actionable wrong committed by the shareholder.

Salomon v A Salomon & Co Ltd: Facts

• Mr. Salomon was a leather merchant and wholesale boot manufacturer with a thriving business.

• He had a wife and five sons, four of whom worked with him and wanted a share in the business.

• Mr. Salomon entered into a preliminary agreement with Adolph Anholt, as trustee for the future company, to transfer the business.

• A memorandum of association was executed by Mr. Salomon, his wife, a daughter, and four sons, each subscribing for one share.

• Salomon Ltd adopted the preliminary agreement.

• Mr. Salomon sold the business to Salomon Ltd and received:

  • 10,000l in cash.

  • 20,000l in fully paid shares (half the nominal capital).

  • 10,000l in debentures (100 debentures of 100l each).

• A share is subscribed if a shareholder agrees to buy it, issued if a company agrees to sell it, and paid if the shareholder pays the price.

• The term "debenture" is over-used and can mean many things.

• Traditionally, a debenture is a secured loan made by the holder to the company.

• The company pays the debenture holder interest periodically and repays the principal at the term of the loan.

• Company assets are used as collateral, transferring to the debenture holder upon default.

• The debentures issued to Mr. Salomon were secured by a floating charge.

• If Salomon Ltd defaulted, ownership of its assets would transfer to Mr. Salomon, making his claim superior.

• Salomon Ltd faced financial difficulties due to a depression in the boot and shoe trade.

• Mr. Salomon obtained a loan of 5000l from Broderip, using his debentures as collateral, and re-lent the money to Salomon Ltd.

  • He returned and canceled the original debentures of 10,000l.

  • Fresh debentures to the same amount were issued to Broderip to secure the loan.

• Broderip was the debenture holder with a superior claim to company assets.

• Mr. Salomon would become the debenture holder once Salomon Ltd repaid the debt to Broderip.

• Salomon Ltd defaulted on interest payments to Broderip. Broderip enforced his security.

• A liquidation order was made at the instance of unsecured creditors.

• Liquidation involves appointing a liquidator to control the company, collect assets, pay debts, and distribute surpluses.

• Secured creditors are paid before unsecured creditors.

• Unsecured creditors include suppliers and customers.

• Broderip was paid off as debenture holder.

• A balance of about 1055l was claimed by Mr. Salomon as beneficial owner of the debentures.

• If Mr. Salomon's claim was sustained, no funds would be left for the unsecured creditors, whose debts amounted to 7733l 8s 3d.

• The question was whether Salomon Ltd was a validly constituted company.

• The Court decided in favor of Mr. Salomon.

• Salomon Ltd was not entitled to be indemnified by Mr. Salomon against the sum of 7733l 8s 3d.

• Lord Chancellor Halsbury reasoned that if the company was a real company, fulfilling all legal requirements, it must be treated as such, with its own rights and liabilities.

• Lord MacNaghten stated that calling such companies "one man companies" is not helpful; if the Act's requirements are met, the company is legally incorporated, regardless of one person's control.

• The case challenged the notion of limited liability itself.

• Economic actors in the form of juristic persons were becoming more common.

• There was concern about the UK becoming "over-corporatised".

Lee v Lee’s Air Farming Ltd: Facts

• Lee’s Air Farming Ltd was in the business of aerial top-dressing.

• Mr. Lee was the controlling shareholder and governing director, as well as an employee (aircraft pilot).

• The company had workers' compensation insurance.

• Mr. Lee died in an aircraft accident while engaged in aerial top-dressing.

• Mrs. Lee claimed compensation.

• Lee’s Ltd (and its insurers) denied the claim, arguing that Mr. Lee was not a "worker" due to his controlling position.

• Lord Morris of Borth-y-Gest stated that there was no impossibility in Mr. Lee being both governing director and an employee.

• Lee’s Ltd and Mr. Lee were separate legal entities. Mrs Lee was able to sue, Mr Lee was a worker.

Macaura v Northern Assurance Co Ltd: Facts

• Macaura owned the Killymoon estate, which contained timber.

• Macaura assigned the timber to Irish Canadian Saw Mills, Ld (Irish Ltd).

• The price was 42,000l, satisfied by allotting Macaura 42,000 fully paid shares.

• Macaura insured the timber against fire with five insurance companies.

• The timber was largely destroyed by fire.

• Macaura claimed against the companies, who declined liability.

• Lord Buckmaster stated that neither a simple creditor nor a shareholder has any insurable interest in a particular asset held by the company.

• Being a simple creditor or shareholder does not enable the creditor or shareholder to sell or use any company asset as collateral.

• Under New Zealand law, there is no longer any need for an insurable interest for most purposes (Insurance Law Reform Act 1985, ss 6 and 7).

Gilford Motor Co Ltd v Horne: Facts

• Gilford Motor Co Ltd was the plaintiff, and Horne was the defendant.

• Gilford sold motors and supplied spare parts.

• Gilford and Horne agreed that Horne would be a managing director.

• Clause 9 of this agreement was a covenant that Horne would not solicit or entice away customers from the company.

• A covenant is a legally enforceable promise, typically not to do something.

• The Court referred to the covenant as a “non-solicitation” or “restraint of trade” clause.

• It could also be referred to as a “non-compete” clause.

• Difficulties arose between Gilford and Horne.

• Horne resigned on the condition that 1500l be paid to him.

• Horne established a business supplying spare parts and service for Gilford vehicles.

• He incorporated “J M Horne Ltd” (“J M” being his son’s initials).

• Gilford brought an action to enforce the covenant by injunction.

• Lord Lawrence stated that the main question was whether the covenant was too wide to be enforceable.

• The Court held in favor of Gilford.

• The covenant was enforceable against Horne and J M Horne Ltd.

• Lord Hanworth stated that J M Horne Ltd was formed as a device to mask Horne's business activities.

Prest v Petrodel Resources Ltd: Facts

• Ms. Prest (wife) was the appellant, and Petrodel Resources Ltd (PRL), Petrodel Upstream Ltd (Upstream), and Vermont Petroleum Ltd (Vermont) (the companies) were the respondents.

• The companies were wholly owned and controlled by the husband.

• PRL owned five residential properties in the UK, and Vermont owned two more.

• The wife petitioned for divorce, which was pronounced in November 2011.

• The wife also petitioned for ancillary relief under the Matrimonial Causes Act 1973, including financial provision orders and property adjustment orders.

• She joined the companies to this petition.

• In the High Court, Justice Moylan noted the husband's failure to disclose assets.

• He made several orders for ancillary relief, including against the companies.

• The question was whether the court has the power to order the transfer of properties legally owned by the companies to the wife.

• The Court held in favor of the wife and ordered the companies to transfer the properties because they were beneficially owned by the husband.

• Lord Sumption stated that the principle of piercing the corporate veil is justified if a company's separate legal personality is abused for wrongdoing.

• He identified two distinct principles: the concealment principle and the evasion principle.

• The concealment principle involves looking behind the corporate structure to discover the facts being concealed.

• The evasion principle involves disregarding the corporate veil if a company is interposed to defeat a legal right.

• Lord Sumption described a limited principle where the court may pierce the corporate veil if a person deliberately evades a legal obligation by interposing a company under their control.

• He noted that this principle is limited because the facts often disclose a legal relationship that makes piercing the veil unnecessary.

• The dicta relating to separate legal personality are obiter, making their binding nature uncertain but highly persuasive.

Company Law: Separate Legal Personality in Groups of Companies

• Companies may be holding companies, subsidiaries, or neither (CA 93, s 5).

• Companies may be related to one another (CA 93, s 2(3)), forming a group of companies.

• Within a group, there is at least one subsidiary (controlled by another company) and one holding company (controlling another company).

• Generally, a director must act in good faith and in the company's best interests (CA 93, s 131(1)).

• In a group, a subsidiary's director may act in the holding company's best interests if permitted by the subsidiary's constitution (CA 93, s 131(2) and (3)).

• If a company is liquidated, the court may treat it and related companies as one (CA 93, s 271(1) and (2)).

• The court may refuse to do so if a parent company cannot immediately direct a subsidiary to perform an act (Lonrho Ltd v Shell Petroleum Co Ltd).

Meaning of Holding Company and Subsidiary (CA 93, s 5)

• A company is a subsidiary of another if:

  • That other company controls the composition of its board.

  • That other company can exercise more than half the votes at a meeting.

  • That other company holds more than half the issued shares.

  • That other company is entitled to more than half the dividends.

  • The company is a subsidiary of a company that is that other company’s subsidiary.

• A company is another company’s holding company if that other company is its subsidiary.

• The expression "company" includes a body corporate.

Interpretation: Related Company (CA 93, s 2(3))

• A company is related to another if:

  • The other company is its holding company or subsidiary.

  • More than half of its issued shares are held by the other company and related companies.

  • More than half of the issued shares of each are held by members of the other.

  • The businesses are so carried on that the separate business of each is not readily identifiable.

  • There is another company to which both companies are related.

Control Defined (CA 93, s 7)

• The composition of a company’s board is controlled by another company if the other company can appoint or remove all or a majority of its directors.

• This includes cases where:

  • A person cannot be appointed without the other company’s exercise of a power in their favor.

  • A person’s appointment follows necessarily from being a director or officer of the other company.

• There are certain matters to be disregarded in determining whether a company is a subsidiary (CA 93, s 8).

Duty of Directors (CA 93, ss 131(1) to (3))

• A director must act in good faith and in what they believe to be the company's best interests.

• A director of a wholly-owned subsidiary may act in the holding company's best interests if permitted by the subsidiary's constitution.

• A director of a subsidiary (not wholly-owned) may act in the holding company's best interests if permitted by the constitution and with prior agreement of the shareholders (excluding the holding company).

Pooling of Assets of Related Companies (CA 93, ss 271(1) and (2))

• On application by the liquidator, creditor, or shareholder, the court may order:

  • A related company to pay to the liquidator part or all of the claims made in the liquidation.

  • The liquidations of two or more related companies to proceed together as if they were one company.

• The court may make other orders to facilitate these actions.

Pooling Assets

• At common law, the holding company and subsidiary are separate.

• Therefore, if a director of a subsidiary acts in the holding company’s best interest, it may be a fraudulent preference. Industrial Equity Ltd v Blackburn (1977) 137 CLR 567, (1977) 17 ALR 575; West Mercia Safetywear Ltd (in liq) v Dodd [1988] BCLC 250 (EWCA).

• To treat related companies as one, the court can put them together.

Lonrho Ltd v Shell Petroleum Co Ltd: Facts

• The case concerned a dispute between Lonrho Ltd and Shell Petroleum Co Ltd (Shell) and British Petroleum Co Ltd (BP).

• Shell and BP are multi-national companies that operate through subsidiary companies in other countries.

• The case involved Shell and BP subsidiaries in South Africa, Rhodesia, and Mozambique.

• Lonrho insisted on further lists of documents located in the countries where Shell and BP subsidiaries exist.

• The Shell and BP subsidiaries did not produce or disclose the documents because it would be in contrary to the interests of the subsidiaries and make them liable to criminal proceedings in South Africa or Rhodesia.

• Lord Denning stated that all documents in possession, custody, or power must be disclosed.

• The subsidiaries are in South Africa and Rhodesia, and the holding company and subsidiary do not have the same power.

• Lord Denning stated that the only documents that Shell and BP have to disclose are those with immediate power. If they have to take further steps, the documents are not in their immediate power and do not have to be disclosed.