Separate Legal Personality of a Company

Since 1897 [i] , the principle of the separate legal personality of a company has become a vital part of company law. This date marks a quasi Copernican revolution of the entire UK system of company law. In fact, while the company legal relationships until that time had been principally based on transactions and activities between ‘natural’ or ‘real’ persons, namely human beings, from that time forward these legal relationships have been increasingly extended also to relations with company, as ‘legal’ personality. Thus, the principle of separate legal personality of a company has conjured up many practical as well as theoretical considerations about its application and correlated consequences.

In this context, the aim of this essay is to discuss and evaluate to what extent the separate legal personality has affected the company law and with what consequences. In other words, whether or not this principle evokes “more questions than it does answers”. In addition, it has to born in mind that this essay does not purport to cover every single aspect related to this principle. However, it more emphasise will be given towards a few aspects which have been considered more controversial and useful to explain the essay’s purpose.

A brief overview of the separate legal personality of a company and its consequences

The separate legal personality of a company, as aforementioned, represents one of the most fundamental principle of company law. Established by the House of Lords in the Salomon case, [ii] this principle delineates the legal relationship between a company and its members. According to this principle, the parts of such relation are thoroughly two diverse legal entities, or legal persons. As Lord Macnaghten stated in Salomon case, “the company is at law a different person altogether from the subscribers to the memorandum”. [iii] In fact, if we consider the procedure of forming a company under Company Act 2006, [iv] once the registrar issues the certificate of incorporation [v] , the company comes into existence with its separate legal personality or, as CA 2006 provides in section 16(2), with its body corporate [vi] and “it may continue in existence indefinitely”. [vii] In other words, a company once incorporated has “dual nature as both an association of its members and a person separate from its members”. [viii] Thus, from that time forward, as Hannigan B. stated in her book, “the company must be treated like any other independent person with rights and liabilities appropriate to itself”. [ix]

The consequences of this separate legal personality are several. As a person separated from its members, it is the company that conducts its business, owns its property, enters into contracts, incurs debts, sues and it is sued, not its members. [x] Therefore, one of the most practical benefit for company’s members is that they are not responsible for the company debt’s except for the extent of their investment in the company. In this regards, as reported by Mayson et al., “it follows that the members of a corporation cannot owe any duty of care in respect of corporation’s acts, that is, they cannot be liable in tort for the corporation’s acts”. [xi]

In addition, in the Salomon case it was emphasised that the company was not the agent of its shareholders or “the trustee for them”. [xii] It follows that a parent company is not the agent of its subsidiaries and vice versa. Thus, the principle of separate legal personality is admitted also for group companies or, as defined by Moore, for “multinational inter-corporate group enterprise”. [xiii] This relation is established between two completely different legal entities, a parent company and subsidiaries, with same consequences as to company and shareholders .

Jurisprudence on the Separate Legal Personality: few case-law

The case-law have assiduously confirmed the application of this principle. In doing this, the different courts have answered some concerns and uncertainties that have risen consequently to the application of such principle. At the same time, however, the courts have showed also dangers that could derive from the application of this principle. Few examples follow to demonstrate this consideration. For instance, considering the business activities of a company, in the event of a defamatory statement towards the company’s business, the company is entitled to sue and to recover damage for liable, as it was recognised in Jamell v Wall Street Journal Europe SPRL. [xiv] This rises two consideration. In the one hand the company exclusively entitled to exercise its rights as human beings, on the other hand, it is limited. In fact, a company is not entitled to be compensated for aggravated damage for injury to feelings, because the company does not have “feelings to be injured”, as stated in Collins Stewart Ltd v Financial Time Ltd. [xv] This is one of the limits of the capacity of a company to enter into legal relationship. The other limit is related to the process of incorporation. [xvi] However, there is another peril. The fact that the company has a separate legal personality and the business’s company is lead by the company rather than its member could have a negative aspect. In fact, the people who are in charge to represent the company in the business could make criminal offences in this activity excusing that those who have committed that crime were the company, not them. [xvii] In this regard, the statute and case-law have shown that the responsible of such offences can be claimed liable. As provided by s. 432(2) Insolvency Act 1986:

“Where a body corporate is guilty of an offence to which this section applies and the offence is proved to have been committed with the consent or connivance of, or to be attributable to any neglect on the part of, any director, manager, secretary or other similar officer of the body corporate or any person who was purporting to act in any such capacity he, as well as the body corporate, is guilty of the offence and liable to be proceeded against and punished accordingly.” [xviii]

According to Mayson et al, from the letter of this provision, it is possible to evaluate that if an individual related to the company offends, then that person and the company “can be both convicted as principals in respect of the same act.” However, in a recent case, Jones v Hellard, [xix] the Queen’s Bench Divisional Court held the liability of an architect who was offering his own service using a false description. Thus, the Court excluded the liability of the company.

Moreover, another example that shows a company as a separate legal personality it is related to the company’s property. In fact, also in this case it is the company which owns its property, not the members. [xx] Thus, as showed for the business, the members cannot claim interests on the company’s property. [xxi] Indeed, in Macaura v Northern Assurance Co Ltd [xxii] , it is possible to see such application of the separate legal personality. Reassuming briefly the facts, Mr Macaura owned a timber estate. He decided to sell his timber estate to a company and in return he received almost all the shares of this company. Thus, Mr Macaura was the sole shareholder and was also the company’s creditor to a large extent. He also decide to insure the timber against loss by fire in his own name. Shortly after, the timber was destroyed by fire and he claimed compensation to the insurance. The insurance company denied to pay out stating that Mr Macaura did not have insurable interest in the timber since the timber were of the company. The House of Lord dismissed the appeal. As stressed by Lord Sumner [xxiii] , Lord Wrenbury clearly and concisely affirmed:

“My Lords, this appeal may be disposed of by saying that the corporator even if he holds all the shares is not the corporation, and that neither he nor any creditor of the company has any property legal or equitable in the assets of the corporation.” [xxiv]

This maxim has been recently applied in Cowan v Jeffrey Associates. [xxv] Therefore, as consequence of the separate legal personality, a company’s member is not entitled to lay claim to rights on the company’s property. Thus he or she cannot sue on behalf of the company. After these example related to the company’s business and property, it appears to be that company’s members do not benefit from the separate legal personality of a company, but in reality this is not true as we will see in the next paragraphs.

As above mentioned, the company, being a separate personality, has the right to make contracts in its name. Thus, for instance, considering a company formed by one shareholder, the company can employ him under a “legally enforceable contract of employment”. [xxvi] As a consequence, such person would be at the same time shareholder, director [xxvii] and employee of the company. Therefore, in such situation if we apply the principle of separate legal personality, there would be, on the one hand the company, on the other hand one person in three functions. Each of them would own rights and obligations.

Indeed, this situation was crystallised in Lee v Lee’s Air Farming Ltd. [xxviii] In this particular case, the question was raised before the Privacy Council due the claim of the widow of Mr. Lee for the compensation [xxix] of her husband, which died while he was working. [xxx] Mr Lee was the only shareholder of the company, the sole governing director of it and he was employed by the company as a chief pilot. Having established that widow of Mr. Lee was entitled to compensation, the Privacy Council stated that: firstly, the company and Mr. Lee “were two separate and distinct legal persons” [xxxi] and consequently capable of establishing legal relations between them; secondly, there was “no reason to doubt that a valid contractual relationship could be created between” the company, “as a master”, and the sole director in quality of employee, “as a servant”; [xxxii] and lastly,

“a man acting in one capacity [sole governing director] can give orders to himself in another capacity[chief pilot of the company] than there is in holding that a man acting in one capacity[employer] can make a contract with himself in another capacity [employee].” [xxxiii]

Therefore, in this case, the application of the principle of separate legal personality of a company clarifies the relation between company’s entities and guarantees the correlated rights such as that of compensation. Thus, the member’s of company would benefit of this separate legal personality. Indeed, the distinction between a director/employee and company, as discerned, assures that the employee will have all the guarantees which derives by such position. As a consequence, one person, although a majority shareholder, may function in two roles as employer and employee within the company without prejudicing the validity of employment contract. [xxxiv] This case has become “the landmark authority” [xxxv] for following cases where a one-man company/employee is questioned.

However, in relation to these particular situations, the respect and application of the separate legal personality have not always been considered wholly. In fact, there are two cases with similar circumstances to Lee case [xxxvi] which were seen as an “attack” to “the sanctity of the Salomon principle”. [xxxvii] In Buchan v Secretary of State for Employment, [xxxviii] it was held that Mr. Buchan:

“As beneficial owner of 50 per cent of the shares in the company he was able to block any decision by the board or of the company a general meeting with which he did not agree, including a decision as to his own dismissal or terms of service.” [xxxix]

Thus, according to the Employment Appeal Tribunal, he “was not an employee of the company”. [xl] Therefore, such decision denied the principle of the separate legal personality of a company as affirmed in the Lee case and consequently it disclaimed the demand of redundancy laid by Mr. Buchan.

The second case which rises concern is Bottrill v Secretary of State for Trade and Industry. [xli] In this case, although the Court disapproved the orientation of Buchan case, [xlii] one of its members Lord Woolf introduced other elements which partially contravened to the principle of the separate legal personality of a company. Lord Woolf, on one hand accepted that the company is a separate entity, on the other he believed that there must be satisfied some conditions. For instance, he supposed that there must be examined the constitution of the company to “establish if the director is only answerable to himself and thereof incapable of being dismissed.” [xliii] Thus, as stated by Howell, this decision of Court, although with a “fair conclusion”, recognises the existence of Salomon principle, but the decision ignores the consequences of such principle. Her critics concludes affirming that “instead of certainty for sole director companies, what this decision has done is allow continued uncertainty.” [xliv]

However, the trend to consider a company separate from its employee has not been followed. Indeed, the application of the principle of separate legal personality of a company in similar circumstances has recurred recently. [xlv] In Secretary of State for Business, Enterprise and Regulatory Reform v Neufeld and Howe, [xlvi] though with different context, the matter at stake was similar to Lee case. [xlvii] Thus, it was essential to determine whether or not a controlling shareholder, at the same time director of a company could be considered as an employee under contract of employment. In this specific case, the aim of the claim was the “employee guarantee payments” from the National Insurance Fund as provided in the event of company’s insolvency. [xlviii] The Court of Appeal, due to the not always coherent evolution of case law in regards to the employment status [xlix] after Lee case, [l] evaluated two test cases for offering clarity in such disputes. [li] In both cases, concerning Mr. Neufeld and Mr. Howe, the Court reaffirmed the value of principle of separate legal personality of a company and consequently considered the respondents as employees. Therefore, it reaffirmed the value of the fundamental principle of the separate legal personality of a company.

Separate legal personality: the major theories, an overview

At the evidence of this evaluation of some of the major case-law related to the principle of the separate legal personality of a company, it is possible to claim that the jurisprudence has assiduously conformed to it. Thus, this corroborates the idea that a company has been recognised as an “artificial entit[y]”. [lii] Such definition have risen different evaluations from the theorists of separate legal personality. Thus, it is necessary a brief exam of these theories. Considering that the concept of artificial entity is the foundation of the “artificial-entity” theory of separate legal personality, this group asserts that incorporation generates an artificial separate person. [liii] As a consequence, that separate person, even though artificial, is regarded by the law similarly as a human being with all the equal capacities to enter in legal relationship. [liv]

However, according to Mayson et. al, there have been several critics to the concept of “fiction” that represents the result of incorporation, namely the separate legal personality of a company. [lv] One group, known as an “individualistic view”, asserts that only individuals can claim legal rights and obligation and it follows that only them can avail of the rights and duties which ensue. [lvi] The individualist view is useful to remind that the principle of separate legal personality is not perfect, there are some problems such as the matter of “piecing the veil”. [lvii] Instead, the group of “realist” theory or “natural-entity” theory focus more on the association of persons. [lviii] For them, this is a real personality, something that the process of incorporation merely recognise. [lix] They refer to the artificial-entity theory as the “fiction theory”, because they evaluate it principally as a “denial of the reality of corporate personality”. [lx] However, the most challenging aspect of the realist theory is to describe the personality which they impute to a corporation. [lxi] Maitland comments this theory affirming that for them a “group-person” is:

“no fiction, no symbol, … but a living organism and a real person, with body and members and will of its own. Itself can will, itself can act; it wills and acts by the men who are its organs as a man wills and acts by brain, mouth and hand.” [lxii]

Thus, realists believe that a contrast should be created between a company as an agent and a company as an organ, something that seems far from the English law. The other two major theories are: the concession theory and contractarians. The concession theory sustains that it is not sufficient an association of people to have a separate legal personality, it is necessary that the State declared a separate personality of such association. Contractarians are not interested in defining the separate corporate personality of a company. They consider a company as a “nexus of contract” and therefore are more concerned on contracts between company’s member. Thus, for them it is essential the freedom of contract without any interference of the State.

Therefore, it is possible to consider that although not all theories recognise the principle of separate legal personality in the same manner, they have developed their own idea in contrast or in favour to it recognising the existence. In fact, this shows how the separate legal personality has been at the glare of the debate between scholars and commentators. However, according to Mayson, none of these theories has never been used to support a case or even to help a court to decide for or against the separate legal personality. They have not been adopted in any legislative forms or claimed in a court judgment. Therefore, these theories have had more effect between the academic world rather than the judiciary one.

Separate legal personality

As seen, the most practical effect of the separate legal personality is that a company can enter into legal relationships on its own name, not its members. It follows that the company’s condition of a separate legal personality entails that when a company has to decide or act for define its legal relationships with the real world, it needs “human agents”. [lxiii] These individuals perform these relationships for the company in its behalf, not in their behalf. Thus, they represent the company as “agents of the company”. [lxiv] The consistent consequence is that these members are not liable for the results of these activities, but the company is liable for them. This assumption is also valid for the relationships between companies which are part of a group. Therefore, a “parent” company would not be liable for a subsidiary and vice versa. As a consequence, each of them owns rights and obligations on their own.

However, such consequence of separate legal personality has not always been evaluated positively especially respect to exclusivity of rights and obligations for a company and not for its members. In fact, it has been developed the idea that at least in some particular circumstances the separate legal personality can be disregarded. These situations are well known as “piercing the veil of incorporation”. Thus, the veil of incorporation and its consequences have affected the decisions of the courts. In other word, considering that a company becomes a separate personality with the incorporation, it has not been easier to affirm when and how to pierce the veil of incorporation. To this concern, two approaches related to the consequences of the separate legal personality have developed. According to Mayson et al., the narrower approach, underpinning that the legal consequences of the separate legal personality attach only to the company and not its members, stems the opportunity to pierce the veil of incorporation only to situations where company’s property, rights and liabilities are held as by another person. [lxv] In addition, according to this approach, it is necessary that one of the legal principles for avoiding the consequence of separate legal personality has to allow the piercing of the veil of incorporation such as in s.213 of Insolvency Act 1986. The wider approach, as the narrower, does not allow company’s member to be considered in relation to the company’s rights and obligations, but it seems that there are no limitation related to legal principles to do so. [lxvi] Therefore, it is necessary to consider few cases for evaluating how these approaches and the previous consideration have affected the separate legal personality on the judiciary reality. The following cases regard the piercing the veil within the group of companies.

In The Albozero case, [lxvii] a “formalistic approach” was adopted by the Court of Appeal. [lxviii] In this case, the dispute was related to the opportunity to sue for loss a subsidiary of the group. The Court of Appeal affirmed that each company in the group was considered a separate entity:

“possessed of separate legal rights and liabilities so that the rights of one company in a group cannot be exercised by another company in that group even though the ultimate benefit of the exercise of those rights would ensure beneficially to the same person or corporate body irrespective of the person or body in whom those rights were vested in the law”. [lxix]

Therefore in this case it is considered that a group of companies has to be seen as separate entities. Thus it was accepted the idea to deem a group of companies as one person.

However, later on this approach was dismissed by the Court of Appeal in DHN Food Distributors Ltd v Tower Hamlets London Borough Concil. [lxx] On different manner, the Court identified the group of companies as one company. Avoiding the details of the case, what is important to highlight is the concept that the Court accepted. According to Lord Denning MR, the subsidiaries were “bound hand and foot to the parent company” and therefore they had to do only what the parent company said. [lxxi] In addition he added that the group of three companies was virtually similar to a partnership and hence they were partners. [lxxii] Therefore, he concluded that this group of three companies for the purpose object of the judgment, which was the right of compensation for disturbance, had to be considered as one, and in the same manner the parent company has to be regarded as that one. [lxxiii] Thus, the parent company was entitled to exercise its right of compensation. [lxxiv] It follows that in this case it was pierced the veil of incorporation on the ground of the specific facts related with it. In fact, this consideration has been stressed by Goff LJ that claimed:

“I would not at this juncture accept that in every case where one has a group of companies one is entitled to pierce the veil, but in this case the two subsidiaries were both wholly owned; further, they had no separate business operations whatsoever”.