COMPANY AS A SEPARATE LEGAL ENTITY AND CORPORATE LIABILITY Flashcards
CHARACTERISTICS OF A COMPANY
- The popularity of companies, as a form of business structure, arises from the fact that they are an artificial creation by law
- The main characteristic of a company is its recognition as a separate legal entity
- Companies are abstract, legal persons recognized by the law as legal persons with rights and liabilities separate from their members (also referred to as shareholders)
- As a consequence, a company has the powers of an individual and is able to do the following under its own name:
› own and dispose of property and other assets;
› enter into contracts;
› sue and be sued;
› have perpetual succession.
COMPANY AS A SEPARATE LEGAL ENTITY
ECONOMIC GOALS ACHIEVED THROUGH LIMITED LIABILITY
Facilitates investment
Promotes market efficiencies
Reduces monitoring
Encourages diversity
ECONOMIC GOALS ACHIEVED THROUGH LIMITED LIABILITY
Facilitates investment
Promotes market efficiencies
Reduces monitoring
Encourages diversity
DOCTRINE OF SALOMON V SALOMON
- The doctrine of separate legal entity was firmly established in the English case Salomon v Salomon & Co Ltd [1897] AC 22
SALOMON V SALOMON FACTS
› Mr Salomon was a sole trader who operated a boot manufacturing business for over 30 years
› He later sold the business for nearly 39,000 pounds, to a limited company he formed, Salomon & Co Ltd. All the requirements of the Companies Act 1862 (UK) were observed
› Mr Salomon held 20,001 shares, while his wife and five children each took up a single share in the company (total shares issued: 20,007)
› However, evidence was raised to show that his wife and five children held their shares as nominees for Mr Salomon – with the result that Salomon & Co was really a ‘one man’ company
› When Mr Salomon sold his business to the company he received more shares and securities in the form of debentures and secured loans from the company in payment
› The company then experienced financial difficulty and went into liquidation
ISSUE IN SALOMON V SALOMON
- The creditors of the company sued Mr Salomon for Salomon & Co Ltd debts, arguing that his company was just an alias for Mr Salomon himself
- Issue: Who was responsible for the debts owed to the creditors? Can the company be considered a separate entity when the major shareholder and office holder are the same person?
DECISION IN SALOMON V SALOMON
› The court held that the company was a separate entity from its shareholders, and that the debt belonged to the company, not Mr Salomon personally
Legal Consequences of the Separate Legal Entity Doctrine
- There is a distinction between private and company debts (Saloman)
- There is a distinction between private and company assets (Macaura v Northern Assurance Co Ltd [1925] AC 619 House of Lords (UK)
- A company can contract with its members (making it possible for a person to act in multiple capacities, for example, as director, shareholder and employee) (Lee v Lee’s Air Farming Ltd [1961] AC 12 Privy Council (UK))
- A company can be liable in tort to a member (Nicol v Allyacht Spars Pty Ltd (1987) 163 CLR)
Macaura v Northern Assurance Co Ltd
- There is a distinction between private and company assets
- Facts:
› Mr Macura owned a timber plantation and sold his business to a company he formed in which he was the main controlling shareholder
› Prior to the sale he had insured the timber in his own name in his capacity as sole trader, he did not transfer the insurance policy to the company; the timber was destroyed by fire
› The insurance company refused to pay under the policy held by Mr Macura because he had no insurable interest in the timber as it was a company asset and therefore belonged to the company - Decision:
› The House of Lords upheld the argument of the insurance company – the company as a separate legal entity owned the timber and did not have an insurance policy.
Lee v Lee’s Air Farming Ltd
- The fact that a member is a controlling shareholder or director does not prohibit them from contracting with the company
- Facts:
› Mr Lee was a major shareholder of a company he formed for the purposes of conducting s crop dusting business; he was also the governing director
› Mr Lee contracted with company to work as chief pilot. The company had taken out a workers’ compensation insurance policy for its employees
› During employment, Mr Lee was flying the plane and was killed in an air crash
› His widow claimed compensation under the insurance policy; the insurance company denied the claim, arguing that Mr Lee was not a worker - Decision:
› It was held by the Privy Council that the widow could claim on the insurance on the basis that the company, as a separate legal entity, could enter into an employment contract with Mr Lee
Nicol v Allyacht Spars Pty Ltd
- Company liable in tort to a member. It is permissible for an injured employee (who is the founder and director of the company) to sue that company for negligence
- In Nicol v Allyacht Spars Pty Ltd (1987) 163 CLR, the High Court allowed an injured employee to recover damages in negligence against the corporate employer for failure to provide a safe system of work despite the fact that the injured employee was also a director/controller of the business
- The court was satisfied that the injured employee, one of three directors, was not solely responsible for implementing the system of work
Piercing the veil of incorporation
- Although the separate legal entity principle has been emphasized as a foundational rule of corporate law, courts have also recognized its limitations certain circumstances
- Since the decision in the Salomon case, it has been recognized that the application of the concepts of the company as a separate legal entity and limited liability can result in undesirable consequences arising from the misuse of companies as shams and facades for deliberately dishonest purposes
- Piercing or lifting the corporate veil means that the separate legal personality of the company is disregarded in carefully defined circumstances under statute and at common law
exception to doctrine of separate legal entity AT COMMON LAW
- Like courts in the UK, Australian courts have been reluctant to disregard the principle in Salomon’s case and pierce the corporate veil
- Company used as a vehicle for fraud
› Re Darby [1911] 1 KB 95
› First instance - Re Edelsten ex parte Donnelly (Unreported, Federal Court, Northrop J, 11 September 1992)
› On appeal - Donnelly v Edelsten (1994) 13 ACSR 196 - Sham or façade (to avoid existing legal obligation)
› Gilford Motor Co v Home [1933] Ch 935
› Sharrment Pty Ltd v Official Trustee in Bankruptcy (1988) 82 ALR 530 (FC, Lockhart, Beaumont and Foster JJ).
exception to doctrine of separate legal entity BY STATUTE
- Directors’ liability for insolvent trading:
› Directors may become liable for debts incurred by the company, where directors breach the duty contained in s 588G by failing to prevent the company incurring debts when there are grounds for suspecting it is insolvent - Uncommercial transactions:
› S 588FB prevents insolvent companies from disposing assets prior to liquidation through uncommercial transactions - Financial assistance:
› Veil can be pierced to render officers liable for civil penalties if they were involved in their company’s contraventions of the Corporations Act (s 260A)
Personally assisting someone in purchasing shares. - Taxation legislation:
› Income Tax Assessment Act 1997 (Cth) provides that directors may be liable to pay the company’s unremitted PAYG tax installments and other similar liabilities
