Legal Entity of a Company

Introduction

Separate legal entity, veil of incorporation and also lifting the veil of incorporation are the three key point issues that can be determined and observed in the Hotel Jaya Puri Bhd v National Union of Hotel, Bar & Restaurant Workers. When the justice is demands, the court will willing to lift the veil of incorporation and the principle of separate legal entity would be temporary ignored.

A company is a legal entity by itself. Under Companies Act 1965, it states that an incorporated company is a corporation that has a separate legal entity or artificial legal person and exists independently. In other words, a company is existed separately from the members, officers, employees as well as the owner of the company. Besides that, in accordance to Marc Moore,

“House of Lords emphasised that the formally separate personality of a company should prevail in the eyes of the law and, consequently, in the opinion of a court, regardless of any economic or moral considerations that might otherwise justify regarding a registered company as the mere extension of its de facto incorporators.”

An incorporated company limits the liability of their members to the share capital they invested, such that no member of the company will be personally liable for all the company’s debts, obligations or acts (Tristan Aubrey-Jones, 2008)

Principle of separate legal entity in an incorporated company is established and confirmed under English law at 1895 by the House of Lords in Salomon v A Salomon & Co. Ltd case. In Salomon v A Salomon & Co. Ltd, the House of Lords in this case held that “corporate personality” of an incorporated company as to distinct itself from its shareholders, even that the company is owned majority and directed by one party. It is the fact that when the company that acts, and therefore the company will be liable. (Tristan Aubrey-Jones, 2008) The company becomes an artificial legal person, so much that it now even enjoys human rights protection, though not to the same extent as a natural persons. (Tristan Aubrey-Jones, 2008) In accordance to Lord MacNaughten in Salomon case, he said that

“The company is at law a different person altogether from the subscribers to the Memorandum and although 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 the trustees for them. Nor are subscribers as members liable, in any shares of form, except to the extent and in the manner provided by the Act.”

The principle of separate legal entity will only exist when a corporation has a proper incorporation. The corporation legal personality is granted by a law and allows one or more natural persons of company to carry out legal activities. This is as in accordance to Lord Denning said,

“That company are, in many ways likened to a human body. They have a brain and a nerve centre which controls what they do. They also have hands which hold the tools and act in accordance with directions from the centre. Some of the people in the company are mere servants and agents who are nothing more than hands to do the work and cannot be said to represent the mind or will. Others are directors and managers who represent the directing mind and will of the company, and control what it does. “

The case of Salomon v A Salomon & Co. Ltd also supported by another leading UK company law case, Adams v. Cape Industries plc which also concerning about principles of separate legal personality and limited liability of shareholders. The precedent set by this case is as same in the Salomon case which related to separate legal entity and treats members and company as separate entities.

In the concept of separate entity, all company’s activities must be treated with its own capacity and existence indefinitely unless provided that the company is officially merged or dissolved. As according to A. Gumbo, ZOU Module,

“The idea of a company entails people or institutions contributing their money to an organization which would then have an independent existence from the contributors”.

Different capacities of people such as owners, directors, managers and employees managing the company as it is an artificial person instead of a human being. As said that it is this depersonalized and reified conception of the company that enable it to be “completely separated” from its members (Gower, 1979).

In accordance to Section 16(5) Companies Act 1965, principle of separate legal entity comes together with a few effect of incorporation after successful register with Companies Commission of Malaysia. There are however another five effects of incorporation such as liability of members are limited, can make contract with its own shareholders, can sue and be sued in its own name, gain the ability to own land or property and as well as has a perpetual succession.

Liability of members is limited in a company which is in contrast to sole proprietorship and partnership, where their liability is unlimited. The liability of members is only limited to the amount agreed upon winding up, thus, they generally have no further liability to contribute when in case of winding up. The company itself will be responsible for all the debt that incurred instead of its officers or members as being stated in the case Re Application by Yee Yut Ee.

In Fairview Schools Bhd v Indrani Rajaratnam & Ors, Mahadev Shanker J said that,

“Limited companies are formed so that its shareholders are not exposed to unlimited liability for the company’s debt. In exchange for this immunity, share capital is pumped into the company which thus becomes available to the company’s creditors.”

Besides that, a company also can make contract with its own shareholders within the company. This is due to the principle of separate legal entity, thus any contract made between company and its members are not illegal. For example in the Salomon case, the company can borrow money or its shareholders can lend money to the company in order to continue operate. Besides that, in the case of Lee v Lee’s Air Farming Ltd, although Lee is the owner of the company, but he is also an employee to the company and thus in result the contract made by him is legal and he is entitled to claim for the insurance by his wife. (David Scrimshaw, 2005)

A company can also sue and be sued in its own name. This is due to the principle of separate legal entity. As shown in the case of Foss v Harbottle, the company but not its shareholders has the right to sue as it is an injury to the company. Besides that, case of Vu Siew Chin v Wong Fah Yoon also can be use to support this point of view. In this case, Wan Suleiman FJ states that law allows that the company’s name being sued by other people. (Aishah Bidin, 2008)

In addition, a company also has the right to own land or property on its own as a result of separate legal entity principle. However, it is also subjected to certain restrictions as stated in the Section 19(2) Companies Act 1965. (Aishah Bidin and others, 2008) The company has the ownership right over the land or property own which distinct from its members. For example in the case of Macaura v Northern Assurance Co Ltd, Macaura cannot claims insurance on the timbers as the timbers belong to the company. A change in the ownership will not affect the ownership of the property. This point of view can be supported in the case of Abdul Aziz bin Atan & Ors v Ladang Rengo Malay Estate Sdn Bhd. It states that transfer of ownership of the shares will not affect the personality of the company itself.

A company also has a perpetual succession which means that company is an continuing entity regardless to the changes in its membership even in the condition that all its shareholders and directors were dead. This can be supported by the case of Re Noel Tedman Holdings Pty Ltd. In this case, both the shareholders and directors were died in a traffic accident, but however, the company still existed. This point of view can also be supported in the case of Abdul Aziz bin Atan & Ors v Ladang Rengo Malay Estate Sdn Bhd. The company will continue to exist until the statutory procedure Section 208 Companies Act 1965 deregistered it. (Aishah Bidin and others, 2008)

Veil of Incorporation

What is veil of incorporation? It can be explained by the doctrine of limited liability. Most people decide to create a company rather than sole proprietorship or partnership instead due to the liability protection factor. This is because a “company veil” will be created between the personal asset of members and shareholders with the company. The veil can also be described like a wall that separating between the company with the members. Anton Behr said that

“Stand behind the veil of incorporation is the principle of limited liability that the court will use to prescribe that a company will be responsible for all the debts that have been incurred instead of its shareholders or members.”

This company veil is one of the main advantages of establishing a company as it will provide a liability protection against lawsuits, creditors. Besides that, members and shareholders can enjoy limited personal liability up to the capital invested in the company when the company winding up.

But however, it is crucial to remember that there are however times where there are some exceptional circumstances where the court would ignore the company principle of separate legal entity by the company and strip the company’s members and shareholders limited liability that they suppose to enjoy. This is what called as lifting veil of incorporation.

Lifting Veil of Incorporation

Lifting the veil of incorporation is a legal decision that treats the rights and duties of a corporation as the rights or liabilities of its owner. (Prof. K. Shanthi Augustin) In a more simple explanation, lifting the veil of incorporation means that the company is treated as identified with its members or directors in some degree of circumstances. Directors and related controlling shareholders have fiduciary duties when carrying out company related conduct, unless they act in negligence or bad faith, then the court would lift the veil and they shall have personal liability. In order to lift the company veil, there are two factors that must be shown. First is there must be fraud or injustice, second is there must be a lack of separate existence. It is also being argued that the existence of an agency relationship between company and its controller is the most common cases that the court will pierce the corporate veil. (Pamela Hanrahan, Ian Ramsay, Geof Stapledon, 2008)

In addition, Junkinson J in the case of Dennis Willcox Pty Ltd v Federal Commissioner of Taxation stated that

“The separate legal personality of a company is to be disregarded only if the court can see that there is, in fact or in law, a partnership between companies in a group, or that there is a mere sham or facade in which that company is playing a role, or that the creation or use of the company was designed to enable a legal or fiduciary obligation to be evaded or a fraud to be perpetrated.”

This can be happened especially in certain circumstances such as when the company is formed to avoid an existing legal obligation or liability and the company is acting as an agent of its controller. (Pamela Hanrahan, Ian Ramsay, Geof Stapledon, 2008). Besides that, the court also held that a person cannot select a corporate form that conform to them and require the court to disregard the legal effect of that form. In Tate Access Floors Inc v Boswell case, Browne-Wilkinson VC said that

“If people choose to conduct their affairs through the medium of corporations they are taking advantage of the fact that in law those corporations are separate legal entities, whose property or actions of their incorporators or controlling shareholders. In my judgment controlling shareholders cannot, for all purposes beneficial to them, insist on the separate identity of such corporations but then be heard to say the contrary when it is no longer in their interest.”

In addition, there are also some cases that can be taken as example where the court ignored the separate legal entity of company and therefore lift the veil. For example in the case Atlas Maritime Co SA v Avalon Maritime Ltd, Staughton LJ said,

“To pierce the corporate veil is an expression that I would reserve for treating the rights and liabilities or activities of a company as the rights or liabilities or activities of its shareholders. To lift the corporate veil or look behind it, therefore should mean to have regard to the shareholding in a company for some legal purpose.” (Amin George Forji, 2007)

Besides that, in the case Pioneer Concrete Services Ltd v Yelnah Pty Ltd, Young J define lifting the company veil as,

“That although whenever each individual company is formed a separate legal personality is created, courts will on occasions, look behind the legal personality to the real controllers.” (Amin George Forji, 2007)

There are two exceptions in which the court can use to lift the company veil when the justice is demands, that are the judicial or common law exceptions and also the statutory exceptions.

Judicial Exception

There are six ways in which the court can lift the veil in judicial exception, that are fraud, agency, sham / facade, unfairness and group of companies.

Fraud

The courts have been more than prepared to lift the corporate veil when it fells that fraud is or could be perpetrated behind the veil. There are two examples of classic cases in the fraud exception which are Gilford Motor Company Ltd v Horne and Jones v Lipman .

In the case of Gilford Motor v. Horne, Horne was the managing director of the Gilford Motor and his employment contract provided that he could not solicit the customers of the company after the termination of his employment. But after he left the company, he formed JM Horne and solicited Gilford Motor’s customer. Thus Gilford Motor brought an action against him. The court granted an injunction against both Horne and his company, having held that he had breached the legal promise. The Court of Appeal found that the company formed just as a medium or a strategy of Horne, the company act as a mere cloak or sham to be used as a device for enabling the contractual obligations to be avoided. Therefore, when justice in demands, the court will lift the veil of incorporation since the incorporating of the new company was to perpetrate fraud and make Horne be liable. (Anusuya Sadhu)

In Jones v Lipman, Lipman agreed to sell land to Jones but before completion of the contract he sold the land to another company. The company was actually formed by him to avoid having to transfer the land to Jones. After that, he claimed that the land no longer owned by him and he cannot act according to the contract. Jones sued Lipman for damages for failure to transfer the land to him. The motive of those behind the alleged facade is relevant in order to determine whether the company is just a façade. The judge ordered specific performance against Lipman and the company. The company was described as a device and a sham which Lipman held before his face in an attempt to avoild obligation. Thus, the court held that it can be proven that there is intention to defraud and there is allegation of fraud being engineered through alter ego companies that are controlled by the same director. Therefore, the court when in the interest of justice will lift the veil of incorporation and make Lipman to be liable for the defraud act done by him. (Clement Chigbo, 2007)

Agency

Agency issue also can be one of the issues for the court to lift the veil of incorporation to solve the disputes between the shareholders and the agents. There are two examples of law cases under Agency issue which are Smith, Stone & Knight v. Birmingham Corporation and Ampol Petroleum Pty Ltd v Findlay.

In the case of Smith, Stone & Knight v. Birmingham Corporation, there are two issues need to be considered by the court which are whether Birmingham Waste Co Ltd (BWC) was an agent for Smith, Stone & Knight Ltd (SSK) and whether it was entitled to compensation from the local government. In this case, Birmingham Waste occupied the premises which owned by Smith, Stone & Knight to operate the waste paper business. Besides, Birmingham Waste was a subsidiary of Smith. Birmingham Corporation wanted to acquire the premises owned by Smith. However, Birmingham Corporation argued that these two companies were two separate entities and refused to compensate Smith. In this circumstance, the court found out Smith, Stone & Knight Ltd, a holding company did not transfer ownership of waste paper business and land to Birmingham Corporation. Therefore, the waste paper business was still the business of parent company and it was operated by the subsidiary as agent of the parent company. (Cyanlts, 2009) Thus, when the justice is so demands, the veil is lifted by the court as Birmingham Waste was the mere agent of the holding company. The subsidiary was maintained by Smith, Stone & Knight. In this circumstance, the agency relationship existed as such the owner of the land, Smith, Stone & Knight was entitled to claim compensation for disturbance of business from Birmingham Corporation.

In the case of Ampol Petroleum Pty Ltd v Findlay, the defendant argued that the veil should be lifted by the court to show that the losses incurred by the company were his loses so that he is entitled claim for compensation. Fullagar J held that

“If the defendant does embark on establishing loss of profits (or capital or goodwill) at an enquiry as to damages, I consider on the present state of the evidence that the “corporate veil” may be pierced for these purposes, that is to say, I consider that the defendant will be entitled to include losses to his company or companies flowing from the breach, provided he establishes (in addition to causation) that the loss to the company was his loss.” (Ian M Ramsay)

In addition, Fullagar J also held that the relevant companies and all assets included their monies was wholly controlled by the defendant. Thus, when the justice of the case so demands, the court lifted the veil of incorporation.

Sham/Façade

An argument that a corporation is a “sham” or “façade” can be used to lift the corporate veil on the ground that the corporate form was incorporated or used as a “mask” to hide the real purpose of the company controller. A facade is “used as a category of illusory reference to express the court’s disapproval of the use of the corporate form to avoid legal obligations, although the courts have failed to identify a clear test based on pragmatic considerations such as undercapitalisation or domination.” A company under scrutiny is a sham or façade is one of the strongest points that would prompt a common law court to pierce the veil of incorporation.

In the case of Re FG Films, the company, FG Films made a film called “Monsoon”. The company had no premises except its registered office and no employees. Film Group Incorporated (FGI), an American company was the one who provided the finance and all the facilities necessary to make the film. FG Films sought to have the film registered as a British Film. This is a sham or facade as the company was not the maker of the film. Therefore, the courts are willing to lift the company veil when fairness and justice are demands so that to make FG Films prohibited from enjoying the benefits given by British government as the film was not made by the company themselves, it is just a sham of the Film Group Incorporated (FGI).

In the English case of Sharrment Pty Ltd v Official Trustee in Bankruptcy, Official Trustee in Bankruptcy of the late Mr. Wynyard’s insolvent estate sought to recover $300,000 arising from a property sale. The property had been acquired sometime earlier following a complicated series of transactions involving many different types of companies and trustees. The Official Trustee argued that these complicated series of transactions were a sham and undertaken for the purpose of putting substantial assets beyond the reach of Mr Wynyard’s creditors. Thus, when justice in demands, the courts are willing to lift the company veil as the transaction involving a sham or façade and Sharrment Pty Ltd has to pay $300,000 to Official Trustee in Bankruptcy. Lockhart J in this case stated that

“A sham is something that is intended to be mistaken for something else or that is not really what it purports to be. It is not genuine but something made in imitation of something else or made to appear to be something which is not. “

Unfairness

The court will lift the corporate veil in cases where it is deducted that there was unfairness on the part of the company in question. The plaintiff may pray for the court to lift the corporate veil on the grounds that doing so would help bring a fair and just result.

In the case of Aspatra Sdn Bhd & Ors v BBMB, BBMB and its subsidiary, BMF sued Lorrain for an account of secret profit while he was the director of BBMB and chairman of BMF. They took injunctions (Mareva and Anton Piller) against Lorrain, Aspatra and other companies which Lorrain controlled. The court held that Lorrain was the alter ego of Aspatra and all the other companies. The court would generally lift the corporate veil in order to do justice particularly when an element of fraud is involved although the consequences of piercing the veil would change according to circumstances of each case. The secret profits made by Lorrain were not denied on affidavit evidence, only the legal capacity under which Lorrain had received them was being contested. In short, the judge found that Lorrain was the alter ego of the companies, and the assets of the appellant companies are in fact and in law Lorrain’s assets.

As in the case of RMS Glazing Pty Ltd v The Proprietors of Strata Plan No 14442, where a body corporate take an action against a defendant company states that his veil will be lifted as its Managing Director had play a very active role in the court proceedings and would usually not have done so if the company was in effect not just a “a body of straw”. As a result, the court in his pronouncement of Cole J rejected this argument, finding that with the company’s record of profitable trading it could not be said to be a body of straw. (Amin George Forji, 2007) Thus, when a company is formed to do unfairness business, the courts are willing to disregard this principle when fairness and justice is demands so.

Group of Companies

The argument of group enterprises is to the effect that in certain companies they may operate in a way that the parent entity is not clearly distinguishable from the subsidiaries. The argument in favour of piercing the corporate veil in these circumstances is to ensure that a corporate group which seeks the advantages must also be ready to accept the corresponding responsibilities.

In the case of DHN Food Distributors v Tower Hamlets London Borough Council, the case concerned a group of three companies running the grocery business. The business was owned by DHN the parent while the premises were owned by Bronze Investments. Another wholly owned subsidiary, DHN Food Transport had the vehicle. Tower Hamlets London Borough Council acquired the land and denied liability to compensate the parent company for the loss of its business since the parent only operated under a license opposed to a lease. The Court of Appeal stressed the significance of the existence of “single economic unit” and recognized the group as a single entity, allowing it to recover compensation but the members of the court were each apparently influenced by different factors. Lord Denning MR held that

“The subsidiary were wholly owned and thus the group companies should be treated as one so that compensation was payable”.

In addition, Goff LJ referred that

“The ownership and the fact that the companies had no business operate outside the group. The owners of three businesses have been disturbed in their possession and enjoyment of it.”

On the other hand, Lord Hanworth also held that

“The company was formed as a device, a stratagem, in order to mask the” the defendant, highlighting his unsavoury motive in forming the company, and thus permitted a lifting of the corporate veil to find him liable.”

In conclusion, the court lifted the veil when justice in demand and treated DHN and its subsidiaries as one economic unit.

The same principle applied in the case of Woolfson v Strathclyde Regional Council. A retail shop setting bridal clothing was made up of different units of property all forming the one shop floor area. Woolfson owned two-third of the shares and the remainder belonged to a company, Solfred which set up by his wife to enable shares to be transferred within Woolfson’s family. Both of them subsequently lodged a joint claim as compensation for the value of the heritage and disturbance. In fact, the true occupier of the premises was company Campbell. Lord Denning expressed the view that,

“At the request of the holding company, a wholly owned subsidiary should be pierced to allow rights to be conferred on the holding company when the companies were in effect a “single economic entity” with the subsidiaries “bound hand and foot” under the complete control of the parent.”

The court argued that Campbell not eligible for compensation as had no property interest in shop since Campbell had not signed an lease agreement with Solfred. Here, when justice in demand, the court should set aside the legalistic view that Woolfson, Solfred and Campbell were each a separate legal entity and focus on Woolfson was the occupier as well as the owner of the whole premises. The corporate veil can be pierced to the effect of holding Woolfson to be the true owner of Campbell’s business or of the assets of Solfred.

Public Policy

Public policy can be characterized as a system of rules and regulations, restrictive measures, types of method, and financing priorities about a given topic declared by a political entity or its representatives.(G. Kilpatrick) As the case shown below, the court applied the action of lift the veil of incorporation when justice in demands.

The case of Daimler Co. Ltd v. Continental Tyre and Rubber Co. (Great Britain) Ltd. shows that the court will lift the veil of incorporation when there are overwhelming public policy grounds for doing so. Continental Tyre Co. was established in England except one of its shareholders was resident in Germany and all its director resident in Germany. The Secretary who was a British subject resided in England held the remaining shares. The issue concerned was whether this company had standing to sue and recover a debt during the First World War when England was at war with Germany. Daimler claimed that the company was owned by Germany and was an alien enemy. Thus, payment of debt will contribute trading with the enemy alien. In fact, the action was ignored on a procedural point but majority of the House of Lords with the opinion that a company could have an enemy character despite the fact that the company had been incorporated in England. This is likely to happen when a company’s agents or persons involved in the control of the company were residents in an enemy country or acting under the control of such person. The court found out that it was a fact that the Germans who were carrying on the business. When justice in demands, the court will lift the veil of incorporation in order to prove that Daimler is innocent and is in his defence. (A.Vijaychandran, 2008)

Statutory Exception

“There are various statutory provisions that allow the court to lift the veil of incorporation. In addition the courts have sometimes recognised that there are occasions when it must be prepared to go behind the corporate veil, but caution will however be exercised by the court, as lifting the corporate veil is an exception and not a general principle of company law.” (Anil Joshi, 2005)

The purpose of lifting the veil of incorporation by the court is to make the officers liable when they breach the Act. Below are seven statutory exceptions that can be use in lifting the company veil.

First, in according to Section 67(3) Companies Act 1965, if a company breaches the prohibition against providing financial assistance for the purchase of its own shares, the Act will when justice in demands, lift the company veil and thus makes the officers in default and liable, but not the company as the guilty of a criminal offence.

Second, the court may also lift the veil of company under Section 121(2)(c) Companies Act 1965 if the publication of company’s name is misstated for trading purposes. This section provides that an officer of the company who signs or is authorized to sign on the companies behalf any bill of exchange, promissory note or cheque where the company’s name is not properly or legibly written is guilty of an offence and the court will make the holder of the instrument liable or order for the amount due by lifting the company veil when the justice is in demands. For example, in the case of Hendon v. Adelman, the directors of L & R Agencies Ltd are personally liable as the company’s name was misstated on the cheque. Thus, when the justice is demands, the court will be willing to lift the company veil.

Third, Section 304 Companies Act 1965 provides that an officer can be personally liable to creditors for debts incurred by the company. This section states that if in the course of the winding up of a company or in any proceedings against a company it appears that any business of the company has been carried on with intent to defraud creditors of the company or creditors of any other person or for any fraudulent purpose, the court on the application of the liquidator or any creditor or contributory of the company, may, if it thinks proper so to do declare that any person who was knowingly a party to the carrying on of the business in that manner shall be personally responsible, without any limitation of liability, for all or any of the debts or other liabilities of the company as the Court directs. There are several examples of law cases that can further support this section. For example, in the case of Re Williams C.Leitch Bros. Ltd, the principle issue of this case was a fraudulent trading as the directors continued to carry on business and purchased further goods on credit when the company was insolvent. Therefore, when the justice is so demands, the court would willing to lift the veil company veil under Section 304(1) Companies Act 1965 in order to make the director personally liable for the debt.

Another case law to support for this section is Siow Yoon Keong v. H Rosen Engineering BV. The principle issue in this case was the Siow, which is the managing director of Ventura Industries Sdn.Bhd, refuse to pay the balance of the debt to Rosen as he had used the company’s fund to invest in shares under his own name. Once he incurred losses on his investment, he intended to transfer the losses to the company. Thus, when the justice is so demands, the court will again willing to lift the company veil by applying Section 304(1)