Introduction
No one could realise today’s business and social environment without the concept of limited liability. It is known that the company is independent and separate from any other things and has its own identities that are related to any company. The solution is in understanding the nature of the company. In matters of company law Salomon v. Salomon & Co., is a foundational decision of the House of Lords and that ruling was to definitely uphold the doctrine of corporate personality. During the past century, the role played by limited liability company in achieving economic and social prosperity with regard to economists, legislative and judicial authorities in Western countries.
This should be treated as a opening in the context of worldwide concern about the use of corporations for unlawful activities. The indication that in the United States whether a corporation’s veil or mask should be pierced is the most litigated issue in corporate law (Thompson, 1998, p.300). Although there are attempt to apply the legal mechanism of pointed the corporate veil in various situations where the participants in legal person enjoy limited liability (Mathew, 2003).
The concepts of Limited Liability Company and corporation employed in a comparative analysis need some additional clarifications. Black’s Law Dictionary defines limited liability Company as “a company, statutorily authorised in certain states that is characterised by limited liability, management by members or managers, and limitations on ownership transfer” (Garner, 1999). Law defines limited liability company as “a legal person with limited liability… whose statutory capital is divided into shares” (Garner, 1999).
Corporate personality and limited liability
‘Piercing the corporate veil’ is the theory that if a corporation is a shell or alter ego of a person who can claim limited liability through the corporate liability shield, the shield can be pierced by creditors in order to reach the assets of the person defrauding them (New S, n.d.). Corporate personality refers to the recognition by the state that definite organisations have legal personality. The Corporations Law states that a company comes into existence as a body corporate on the day it is registered by the British Securities and Investments Commission. By tradition in the United Kingdom, this meant that a company has a legal entity with the legal capacity and powers. It could sue and be sued in their own right, without having to rely on the rights of the members of the organisation (Chigbo, March 2006).
Company is piercing the corporate veil. By the mid nineteenth century, the difficult concerned in obtaining a grant of corporate status from parliament forced businesses to utilize the trust instrument to form “deed of settlement” companies. These companies were extremely complex legal entities that were sometimes used as instruments of fraud. A company once incorporated becomes a separate legal personality and the liability of the members are said to be limited. But there is a difference between the two. Limited liability is the logical significance of the existence of a separate personality.
But however, just as human can have restriction imposed on their legal personality. For example, in the case of children, a company can have legal personality without limited liability if that is conferred by statute. However, a company may still be formed today, that is, as registered unlimited company without limited liability.
Separate Legal Personality
An incorporated company has an artificial personality distinct from its members. Corporate personality became an characteristic of the normal joint stock company at a comparatively late stage and its was not until the celebrated case of Salomon v Salomon & Co., (1897) and its facts are given below:
In the above-mentioned case, Aron Salomon was a boot and shoe manufacturer trading as a successful sole trader in the East End of London for over 30 years. There was pressure by members of the family to give them a share in the business and he wished to extend the business. At the time the legislation required a company to have a minimum of seven members. The 1862 Act created limited liability companies as legal persons separate and distinct from the shareholders. House of Lords said that there is neither fraud in the manner which Mr. Salomon formed the company. Mr. Salomon did not form the company for fraudulent purpose.
So, Mr. Salomon did not have to pay to the company’s creditors since Mr. Salomon and the company is two separate legal entities. The company is separate from its members. Lord Macnaghten asked what was wrong with Mr. Salomon taking advantage of the provisions set out in the statute, as he was perfectly entitled to do. In modern days since Salomon’s case, legislatures and the judiciary both in England and elsewhere courts can legitimately disregard a company’s separate legal personality, such as where crime or fraud has been committed.
“In effect, the court will look behind the corporate entity to assign a corporate right, privilege, duty or liability to a member of the company where a strict application of the separate legal personality doctrine would vest the liabilities or rights solely in the company” (HALSBURY’S LAWS).
Court lifted the Veil
Since Saloman case to even today, the complete separation of the company and its members has never been doubted. To some extent courts have lifted the veil of incorporation. The general rule prevails that a company is a legal entity distinct from its members. There are some cases where the legislature thinks so. If a trader transfers his business to a company owned by him he will stop to have interest in the property of the company. If he has forgotten to assign the insurance policy to the company remains without any insurance (Macura v. Nortern Assurance Co., 1985). The Macaura decision is a very good example of the separation of shareholders property from the company’s. The company as a separate legal entity owns its own property and there is no legal connection between a share in the company and the company’s property.
In recent years, the courts have shown a welcome tendency to recognize the economic reality in applying the legal rules to such incorporated partnerships (Ebrahimi v. Westbouene Galleries Ltd., 1973). Easterbrook and Fischel (1991) add that limited liability reduces operating expenses of corporation and limited liability increases efficiency of managers. The market value of shares is in most part related to their actions as opposed to other shareholders’ assets.
Historically, pressure toward limited liability occurred with a separation of ownership and control. Limited liability principle of risk transferring limited liability regime is that a substantial portion of the risk of business failure shifts to creditors and away from shareholders (Solomon, 1998, p.300). Therefore, discussing the concept of limited liability in the context of the corporate veil piercing, one should balance social and economic advantages of shareholders’ limited liability. It is against the principle of separation between ownership and control that public could tolerate.
Lifting the Veil under Case Law
The legal mechanism of piercing the corporate veil is as typical to the country of common law tradition. It is dedicated to dealing with the misuse of corporate limited liability protection. Although the purpose of piercing the corporate veil is not difficult to distinguish, the content or the structure of this legal mechanism is an issue. As Hofstetter (n.d.) suggests, “its uncertain and metaphoric name is partly reflected in its application: U.S. courts refer to it in very different situations, and it is not easy to detect a coherent theory behind the uses of the concept”.
In the case of Adams vs. Cape Industries plc. (1990), the English court of appeal gave a classic judgment and examined the issue exhaustively. In the case of D.H.N.Food Distributors Ltd. vs. Tower Hamlets L.B.C., (1976) was concerned with compensation to be paid to the parent company when land belonging to a subsidiary was compulsorily acquired. As judge Fuld stated in Walkovszky vs. Carlton, (1966) “broadly speaking … courts will pierce the corporate veil, whenever necessary to prevent fraud or to achieve equity”. Legal mechanism of piercing the corporate veil is equitable remedy and the courts will place the burden on plaintiff to establish that equity requires deterring from a general rule of limited liability (Dewitt Truck Brokers vs. W. Ray Flemming Fruit Co., 1976).
The case of Kinney Shoe Corporation v. Polan (1991) is famous example illustrating the application and the courts discuss “when… such party will be charged with the knowledge that a reasonable investigation would disclose”. In the case of Lee v. Lee’s Air Farming Ltd (1961), Mr Lee incorporated a company was the vast majority shareholder, he was the sole governing director for life and he was an employee of the company (Bajaj, 1998). According to Lord Morris the substantial question arises and Lordships think, whether the deceased was a “worker” within the meaning of the Workers’ Compensation Act, 1922, and its amendments. The Court of Appeal thought that his special position as governing director precluded him from being a servant of the company (Scrimshaw, October 2005).
The cases of Jones vs. Lipman (1962), where a company was used to defraud the creditors of the defendant and Gilford Motor Co Ltd vs. Horne (1933), an injunction was established to prohibit setting up a business. Similarly, in Gencor vs. Dalby [2000], the tentative suggestion was made that the corporate veil was being lifted where the company was the “alter ego” of the defendant. In general, it is because of the different entity and identity of the company perspective and not despite and that was noted extra-judicially in according with Lord Cooke (1997). They are not instances of the corporate veil being pierced but instead involve the application of other rules of law (Graham and Jensen, 2005).
Conclusion
Neither a shareholder nor a creditor of a company has an insurable interest in the asset of the company (Bajaj, 1998). Shareholders generally benefit from this because it facilitated limited liability, as the company also owns its own debts (Subject Guide: Company Law). “Rest assured that the company is treated at law as if it was a separate personality from its members. This no doubt facilitates the limitation of the members’ liability, as the company is responsible for its own debts” (Chigbo, March 2006).
In the case of Hefferon Kearns Ltd. Mr. Justice Lynch stated in his judgment that it was not in the interests of the community generally that “whenever there might appear to be any significant danger that a company was going to be insolvent, the directors should immediately cease trading and close down the business” (LK Shield, January 2008). It is, in many respects, unsatisfactory in case of the application of limited liability to private owner-controlled companies. “In the absence of another incentive-driven system, however, it is necessary to consider the doctrine in the light of its achievements” (Aiden, n.d.).
The aim of any future legislation should be to control the benefits of the doctrine and minimize the undesirable side effects, by imposing greater disclosure and minimum capitalization requirements having regard to practical requirements. Nevertheless, limited liability must continue to exist as a fundamental consequence of incorporation (Aiden, n.d.).
References
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