The Company Is at Law a Distinct Person All Together From Its Members

The Question

“The company is at law a distinct person all together from its members. A company is not at law the agent of its subscribers or trustees for them.”

The on top of statement is an initial decision of the House of Lords in the part of company law. The cause of the Lords’ widespread declaration was to definitely maintain the principle of corporate traits, as set out in the Companies Act 1862. The main theme is,

“A Company is separate from its shareholders and directors”.

An additional part of this statement is:

“The company is at law a different person all together 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 of the subscribers or trustees for them.”

The statement in the question is layered from the Lord Mac Naughten in Salomon Salomon & Co. Ltd [1897]. It simply means that the company is independent and separate from any other entities that are related to the company.

INTRODUCTION

“A company is nothing but a group of persons who have come together or who have contributed money for some common person and who have incorporated themselves into a distinct legal entity in the form of a company for that purpose”. 1

‘The word company is traced from in 1150 A.D. from a term compaignie or “body of soldiers” and from companio (companion) 2. The word’s meaning of “subdivision of an infantry regiment” is from 1590. The use of the word in a sense of “business association” was first recorded in 1553, having earlier been used in reference to trade guilds (1303) 3. The abbreviation co. dates from 1769. In short a company can be defined as an artificial person having a separate legal entity, perpetual succession and a common seal. It is not affected by the death, lunacy or insolvency of a member.

As far as the law is concerned it is not only the human beings who can be counted as persons. In some cases, the law creates artificial persons, such as companies and corporations, which are dealt with legally as if they are people. This is called having legal personality.

1 A Two-Edged Sword: Salomon and the Separate Legal Entity Doctrine. (September 2000). Murdoch University Electronic Journal of Law. 7(3). [ Electronic version]. Retrieved on November 27 2008 from

2 http://www.murdoch.edu.au/elaw/issues/v7n3/puig73a_text.html#Conclusion_T.

3 http://www.en.wikipedia.org/wiki/Salomon_v_A_Salomon_&_Co_Ltd

As well as individuals, groups of people- such as companies, schools and councils can have legal personality. They are broadly called corporations and they allow the law to treat the group as separate from the individual who operate or own it. There are three basic types of corporation.

Corporation Sole

Corporation Aggregate

Limited Liability Partnership

SALOMON’S CASE

Mr. Aron Salomon was a leather boot and shoe manufacturer. His firm was in Whitechapel High Street, with warehouses and a large establishment. He had it for 30 years and “he might fairly have counted upon retiring with at least £10,000 in his pocket.” He had a wife, a daughter and five sons. Four of the sons worked with him. The sons wanted to be partners, so he turned the business into a limited company. The wife and five eldest children became subscribers and two eldest sons also directors. Mr. Salomon took 20,001 of the company’s 20,007 shares.

The price fixed by the contract was £39,000, which was “extravagant” and not “anything that can be called a business like or reasonable estimate of value.” Transfer of the business happened on June 1, 1892. Purchase money for the business was paid, totaling £20,000, to Mr. Salomon. £10,000 was paid in debentures to Mr. Salomon as well (i.e., Salomon gave the company a loan, secured by a charge over the assets of the company). The balance paid went to extinguish the business’ debts (£1000 of which was cash to Salomon).

But soon after Mr. Salomon incorporated his business, there was economic trouble. A series of strikes in the shoe industry led the government, Salomon’s main customer, to split its contracts between more firms (the Government wanted to diversify its supply base to avoid the risk of its few suppliers being crippled by strikes). His warehouse was full of unsold stock. He and his wife lent the company money. He cancelled his debentures. But the company needed more money, and they sought £5000 from a Mr. Edmund Broderip. They gave him a debenture, the loan with 10% interest and secured by a floating charge. But the business still failed, and they could not keep up with the interest payments. In October 1893 Mr. Broderip sued to enforce his security. That was the end. The company was put into liquidation. Mr. Broderip was paid but other unsecured creditors were not.

The new company went bankrupt shortly afterwards still owing £10,000 purchase price of Salomon and £7,000 to other creditors. It assets only followed £6,000 and Salomon was a secured creditor, giving him a prior claim to the all assets over the other unsecured creditors, The creditors urged that Salomon was disqualified from claiming against those assets because he was the company and the sale was a sham. The Trial Judge and Court of Appeal agreed and gave the creditors prior claim to the assets. The House of Lords unanimously reversed the Lower Courts decision.

In giving his reasons for overturning the decision of the Court of Appeal, Lord Macnaghten stated: “the company is at law a different person altogether from the subscribers 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 of the subscribers or trustee for them. Nor are the subscribers, as members liable, in any shape or form, except to the extent and in the manner provided by the Act”4.

As a result, Salomon was preferentially entitled over the assets as secured creditor and so was entitled to be paid.

The significance of Salomon’s case is, the case is universally recognized as authority for the principle that a corporation is a separate legal entity. The case firmly established that upon incorporation, a new and separate artificial entity comes into existence. At law, a corporation is a distinct person with its own personality separate from and independent of the persons who formed it, who invest money in it, and who direct and manage its operations

4 Salomon v. Salomon & Co. In Wikipedia The free Encyclopedia. Retrieved on November 27 2008, from http://en.wikipedia.org/wiki/Salomon_v._Salomon_&_Co.

Where the company is being used as a mechanism to avoid legal obligations:

The Court has drawn a distinction between the avoidance of existing legal obligations and the avoidance of future legal obligations. The courts have shown a willingness to disregard the separate legal personality of a company where it is being used as a means of avoiding existing legal obligations. However in respect of future legal obligations, the courts have shown reluctance to disregard the separate legal personality of a company.

Company as a separate legal entity

At its most general level, the decision of the House of Lords in Salomon v Salomon & Co Ltd was a good decision. Salomon’s case is universally recognized as authority for the principle that a corporation is a separate legal entity.

The case firmly established that upon incorporation, a new and separate artificial entity comes into existence. “At law, a corporation is a distinct person with its own personality separate from and independent of the persons who formed it, who invest money in it, and who direct and manage its operations” 5. It follows that the rights and duties of a corporation are not the rights and duties of its directors or members who are, most of the time, obscured by a corporate veil surrounding the company.

The recognition that a corporation is a separate legal entity in its own right is the foundation of modern corporate law: MacLaine Watson & Co Ltd v Department of Trade and Industry. Indeed “every system of law that has attained a certain degree of maturity seems compelled by the ever increasing complexity of human affairs to create persons who are not men…”6 Consistent with this observation, Arnold states that “one of the essential and central notions which give our industrial feudalism logical symmetry is the personification of great industrial enterprise.”

5 http://www.pmo.gov.bd/constitution/index.htm ( visited date 20th June, 2008)

6 Sen, A. k., Mitra, J. k. (2002). Commercial law and industrial law.

A Limited Liability Company

A limited liability company in the law of the vast majority of the United States is a legal form of Business Company offering limited liability to its owners. Often incorrectly called a “limited liability corporation” (instead of company), it is a hybrid business entity having characteristics of both a corporation and a partnership. It is often more flexible, the owners have limited liability for the actions and debts of the company, and it is suitable for smaller companies with a single owner. The primary corporate characteristic is limited liability while the primary partnership characteristic is the availability of pass-through income taxation.

“ The Limited Liability Company is a separate legal entity and liabilities do not pass on to the members. The management and organization of the Limited Liability Company are flexible and governed by the Membership Agreement” 7. Owners may manage the Limited Liability Company, where all owners vote on all issues or managers may manage it. The owners elect one or more managers, much like a board of directors. These managers manage the business, freeing the owners from voting on every operational detail. The IRS does not recognize the Limited Liability Company as a separate category. “A single member Limited Liability Company has to file as sole proprietorship while the multi-member Limited Liability Company may chose to be taxed as corporations or partnerships” 8. Support for the principle of the separateness of legal personality, shared amongst academic commentators, has been unbroken in legislative and judicial circles. Notably, this principle is enshrined in section 124 of the Corporations Act. Similarly, the judiciary has, with minor exceptions, consistently reaffirmed the need to treat this legal doctrine seriously. Subsequent English and Australian judicial decisions have upheld the Salomon principle. In other words, since the decision in Salomon’s case, the complete separation of the company and its members has never been doubted.

7 John Gooley, Corporations and Associations Law: Principles and Issues (3rd ed, Butterworths, Sydney, 1995), p 112. [ Electronic version] . Retrieved on November 27 2008 from http://en.wikipedia.org/wiki/Salomon_v._Salomon_&_Co.

8 The Daily Star; 24th March, 2007 (http://www.thedailystar.net/law/2007/03/04/opinion.htm); visited on 20th June; 2008 (Para-7)

From a hypothetical perspective, the answer is simple. All theories of the corporate entity agree on the practical need for the artificial personality with which the legal system invests corporations. Concession theorists, for example, regard corporate personality as a privilege granted by the state “for legal and business convenience”. Similarly, the contract Arian school argues that. Corporation law reduces transaction costs by implying in every corporate charter the normal rights on which shareholders could be expected to insist”, such as separate legal status. This principle, the essence of corporate law, is said to operate as a default provision that facilitates corporate activity.

“We have seen how the principles of separate legal personality and limited liability sometimes result in circumstances that may seem favorable to the Company’s shareholders and detrimental to its creditors” 9. On one hand, there are good reasons for retaining these principles. The Courts feel that to subject individual shareholders or directors to onerous personal liabilities would discourage commercial enterprise. Additionally, whilst creditors are exposed to risk, they are fully aware of this risk: the Company’s Memorandum, a public document, freely states that the company is limited by shares, the liability of its members is limited, and by how much. So when the Company “proceed[s] to trade with all who’ll trust ’em”, the risk creditors take is easily calculable.

On the other hand, there are cases where, if it were not for company law, other principles would require the Courts find individual members liable for their debts and actions. Cases such as Adams v Cape Industries, where members have deliberately arranged their affairs to avoid liability if sued, are difficult to correlate with equitable principles of justice. The law is moving towards introducing provisions to prevent members abusing the principles to avoid liability for serious crimes and should go further to introduce provisions preventing the avoidance of liability for serious losses.

9 Sealy, L,. & Worthington, S,.Cases and materials in law. 8th Edition. Retrieved on November 27 2008 from http://books.google.com.bd/books.

Shareholders

Shares can either be available to the public or the private owners. If the shares are available to the public, it is called a “public” company. If the shares are available to private owners, it is called a private (proprietary) company. We will deal solely with private companies.

Responsibility of directors

Director should first understand his association with the company and the shareholders as this relationship is what shapes his roll. Unfortunately, there is no statutory provision to define this relationship. It is the judiciary, which has over a period defined the relationship.”As early as in 1866, that is about a century and half back, in Ferguson vs. Wilson, the Chancery Division held that a company though a legal entity, cannot act by itself” 10. It can act only through its directors and as such the relation of a director with the company is that of principal and agent and therefore general principles of law of agency would govern the relationship between the company and the directors. “The relationship was further defined in Forest of Dean Coal Mining company case by Chancery Division in 1878 that directors, having been entrusted with the affairs of the company, are trustees of the company and therefore they are in a fiduciary relationship with the company.”11 “ This relationship would mean that the directors should always act in the interest of the principal that is the company and in discharge of their fiduciary responsibilities, they cannot benefit at the cost of the company.”12

10 Griffin, S. (2005). Company law (fundamental principles) 4th edition. Washington, DC.

11 Lowry, J., Dignam, A. (2008-2009). Company law

12 http://www.thedailystar.net/story.php?nid=9805; (visited June20, 2008)

CONCLUSION

The main reason for recognizing the legal personality of a company is the convenience of doing so. Sometimes, separate legal personality and limited liability sometimes may seem favorable to the Company’s shareholders and unfavorable to its creditors.”In some cases (such as Adams v Cape Industries) individual is liable for their debts and actions.”13

From the above discussions, it shows that individuals, groups of people- such as companies, schools and councils can have legal personality. They are broadly called corporations and they allow the law to treat the group as separate from the individual who operate or own it. “Corporation sole makes it possible to continue the official capacity of an individual beyond their lifetime or tenure of office and corporation aggregate covers group of people with a single personality14. Today, Salomon’s case is the leading case for separate legal entity of a corporation. So, it shows that “the company is at law a distinct person altogether from its member, the company is not in law the company is not in law the agent of the subscriber or trustees for them.”15

13 Sealy, L,. & Worthington, S,.Cases and materials in law. 8th Edition. Retrieved on November 27 2008 from http://books.google.com.bd/books.

14 Singh, Avtar (1966). Company Law (14th Edition). Eastern Book Company.

15 http://en.wikipedia.org/wiki/Limited_liability_company