Meaning and Effect of Separate Legal Personality

1. “The company is at law a different person altogether from the subscribers to the memorandum; and though it may be that after incorporation the business is precisely the same as it was before, and the same persons are managers and the same hands receive the profits, the company is not in law the agent for the subscribers or trustees for them. Nor are the subscribers as members in any shape or form, except to the extent and in the manner provided by the Act.”

Salomon v. Salomon & Company Ltd [1897] AC 22.

With reference to case law discuss the meaning and effect of Separate Legal Personality.

When a company is formed by registering under the Companies Act 1985, it becomes a corporation with different characteristics from that of a partnership or other unincorporated body. Corporations can be compared to a human in that it is an ‘artificial person’ as it has a separate legal personality, in comparison of that to a natural person (Davies, 1997: 77). The benefit of having a company is that the people running it are completely separate to its owners so if either changes throughout the life of the company, the business does not need to wind up and begin all over again. Companies can also enjoy the benefits of limited liability in that stakeholders will only lose what they have invested if the company does go into administration.

The case that helps us understand separate legal personality is that of Salomon v. Salomon & Co. Ltd (1897) AC 22. Here Mr. Salomon incorporated his sole trader business into a private limited company in order to provide his family with some personal stake in the business. Mr. Salomon became the clear majority shareholder, enjoying 99% of the shares along with a £10000 debenture while his wife and 5 children held one share each. This complied with the legislation at the time being a company had to have 7 members. Unfortunately the company faced trading difficulties and went into liquidation. Although there were attempts from creditors and liquidators to hold Mr. Salomon liable for the debts of the business, the House of Lords held that Mr. Salomon and the business were separate entities due to the ‘veil of incorporation’. Farrer & Hannigan (1998: 68) describe the somewhat humorous, yet compliant comment from the Law Quarterly Review in reference to the case:

‘The House of Lords had recognised that one trader and six dummies would suffice and that the statutory conditions were mere machinery.’

Therefore the formation of the company was perfectly legitimate and the veil of incorporation was what made Mr. Salomon the individual, different from Salomon & Co. Ltd once all rules and regulations had been complied with.

This said there can be occasions where the corporate veil is lifted in order to obtain access financially to the members of the company. Whilst there can be many reasons for the corporate veil to be lifted, the rule of thumb is when it’s in the interests of justice to do so. The veil can be lifted in two different ways, by legislation or by the courts. Where the company has less than 7 members for more than 6 months, everyone can be held responsible for debts incurred by the company during that time under legislation. An individual within a company may also be taken to court where they were aware tax evasion was occurring. In the case of Gilford Motor Co. Ltd v Horne (1933) Ch 935 CA, a Managing Director of a company agreed not to petition customers from his employees. When he was leaving employment he set up his own company and began to implore customers but the courts ruled that this was purely to hide his own mismanagement in the old company and held him liable for fraud. Legislation may also highlight fraudulent trading, reckless trading, and the existence of a group of companies. Barber (2001: 24) highlights the effects of fraudulent or wrongful trading:

‘The directors will be personally liable to contribute towards paying the company’s debts. The distinction between them and the company as a separate persona is disregarded.’

If the courts decide to lift the corporate veil, they will do so where they feel it is reasonable and equitable. When an English subsidiary was formed by an American company so that they could make and sell tyres in the European market in the case of Firestone Tyre & Rubber Co. V Llewllin (1957) 1 All ER 561, the courts held the American company was liable to pay tax on the profits of the subsidiary. Even though the subsidiary was independent in its day to day business, it would transfer profits to the American company after deducting a specific sum. The courts ruled that the subsidiary was an agent for the American company and it was therefore liable to pay tax on the English profits.

Similarly, the courts may decide to lift the veil where a group of companies should be treated as one unit. This happened in Holdsworth & Co. V Caddies (1955) W.L.R. 352, H.L. where Caddies was the managing director of the Holdsworth parent company. It was argued that he could not be disciplined to dedicate all his time to the subsidiaries given they all had their individual board of directors. Lord Reid at 367 said “an agreement in re moratoria and must be construed in light of the facts and realities of the situation” (Davies, 1997: 167). As their argument was too technical it was discarded. In the courts eyes if the company has been formed for fraudulent reasons or to perpetrate an injustice against minority shareholders, the veil may also be pierced.

There are many obvious benefits to forming a company but there can also be consequences. The veil of incorporation only allows for legal action to be taken against the company, not individuals within it. Shareholders do not have holdings on any property the company considers an asset. Limited liability means only the company is liable for its debts. Shareholders give up all say in the business once they sell their shares to another party. A company will still exist even where members pass away as it is an entity in its own right. Corporation tax is also to the company’s disadvantage while it needs to ensure certain information is made available while making returns to the Companies Registration Office. All benefits and detriments should be considered before wishing to form a company.

We have seen how a company is completely separate from shareholders and those individuals running it. The veil of incorporation allows the company to be treated it if were indeed an individual itself. Dine (2005: 25) defines the very obvious benefits of starting a company:

‘Is is free to develop as an instrument of business shaped by both the people involved in its running and those regulating its existence.’

A company will survive regardless if management changes frequently or even if shareholders sell up. Provided it can comply with all regulations of the Companies Acts it will remain until such times where it is decided to wind up the business or if they face unfortunate administration.

2. “A company being a legal entity can enter into contracts as an individual can. It is however subject to one major limitation from which the individual is free: it cannot enter into a contract which is ultra vires.”

Company Law, Ronan Keane

Discuss the concept of Ultra Vires in relation to Company Law.

When a company is forming it must draw up a memorandum of association which includes the objects of the company. As this document is made public, any outsider who enters into a contract with the company which then acts beyond the powers of their memorandum, cannot enforce that contract on the grounds that they were unaware of the contents of the documents. An ultra vires transaction was unenforceable at common law as it was automatically void (McAleer, 2010: 35). This resulted in much hardship which is displayed in the case of Re Jon Beauforte (London) Ltd (1953) Ch 131. The object set within the memorandum of this company set out that they were in the business of dress making. At such times, the business began to manufacture veneer panels and displayed this on its note paper. When the supplier of coke to the company took them to court over payment of the delivery, it was held that the supplier was given sufficient notice of the fact the company now made veneer panels when in fact it was ultra vires of its memorandum. This resulted in the contact being void and nil payment to the supplier.

The case of Introductions Limited v National Provincial Bank Limited (1968) 2 All ER 1221, resulted in a similar outcome and here it was decided to draft clauses of independent objects and “Bell Houses”. Dine (2005: 53) describes the independent objects clause:

‘The main object of the company could be determined either from the name of the company or from the first named object on the list of objects.’

Any successive statements in the objects clause could only be used to further the main object. In Cotman v Broughman (1918) AC 514, the draftsman was successful in avoiding this clause when drawing the statement of objects but this was subject to much criticism. The Bell Houses clause permitted companies to perform contracts that the Director deemed to be of advantage to the company. The case of Bell Houses Ltd v City Wall Properties Ltd (1966) 1 QB 207 shows how the Court of Appeal upheld the validity of such a clause. The plaintiffs had knowledge of the financial world and the defendants agreed to pay commission to the plaintiff so they would introduce them to Swiss Bankers in order to obtain lending for property development. When the defendants refused to pay the agreed commission, they were taken to court where it was ruled that the commission was valid. Keane (2000: 146) argues:

‘Whilst doubts have been expressed as to the correctness of this view, it would seem a logical corollary to the general ultra vires rule which remains the law notwithstanding its statutory modification in favour of outsiders seeking to enforce such contracts.’

We understand that the memorandum must contain objects but these need to be distinguished from powers. In Hutton V West Cork Railway Company (1883) 23 Ch D 654, we see how a company wanted to give away money in excess of its powers. The Court of Appeal ruled that payments to employees for loss of work when the company was about to be dissolved would be invalid (Dine, 2005: 55). The company may have had the power to give out money however it was not in its best interests to do so. Other acts that may be incorporated in the objects clause as a power to the company are, holding shares in another company or borrowing money and subsequently issuing bills of exchange.

Legislation stipulation has impacted on outsiders with the ultra vires ruling. Section 8 of the Companies Act 1963 established an alteration where outsiders can only enforce the ultra vires rule where they are not aware that the transaction is outside of the powers of the company. The Courts view this reform scarcely and believe that if a person digests the memorandum of a company but possibly misreads it, that person will not have grounds under this section. The plaintiff in the case of Northern Bank Finance Limited v Quinn & Achates Investment Company (1979) ILRM 221 was not afforded any protection under Section 8 of the Act. When the defendant defaulted on a loan issued by the plaintiff, they took them to court to recover the cost. The Investment Company had the power to guarantee its own loans but not that of a third party, in this case Quinn. It came to light that the solicitor of the Bank had read the Memorandum of Achates but failed to notice that guaranteeing third party loans was outside of its objects. Similarly, in Bank of Ireland v Rockfield (1979) IR 21, the Courts ruled Section 8 would not hold where a company wanted to purchase shares in itself under circumstances that were disallowed under the Companies Act as this contract was not lawful in the first place.

Another legislation addition to that of the above was Regulation 6 of the European Communities (Companies) Regulations 1973. Keane (2000: 145) describes its relationship to the previous legislation:

‘It is certainly more limited in its application than s 8, since it is confined to contracts entered into by the board of directors and registered agents and does not apply to unlimited companies.’

Unless you are able to prove good faith did not exist, a contract that a Director of a company enters into will be looked upon as if they have the appropriate authority and will be enforceable. This is evident in the case of International Sales & Agencies Ltd V Marcus (1982) 3 All ER 551. When a major shareholder became ill, his friend Marcus agreed he would repay loans to some companies. The defendant, who was a director of the two companies, repaid the loans using company cheques. Lawson J, made it clear that it was the lenders responsibility to establish dealing and the lack of good faith be recognized from the companies. Marcus used the companies as the medium of his generosity and it was clear there were no actual dealings with the company (Farrar & Hannigan, 1998: 111).

We have established how the effects of an ultra vires contract can render it unenforceable and companies should make certain they act within the object of their memorandum. In old law, it was assumed everyone would know the contents of the memorandum of association under constructive notice. But in more recent times and as we have identified above, there are now grounds in which a third party can challenge this. Nevertheless, anyone wishing to enter into a specific contract with a company is strongly recommended to read, digest and understand that company’s Memorandum of Association so they don’t fall foul of the ultra vires rule.