Limited liability and corporate personality Flashcards
Limited Liability
There is a distinction between two groups of trading structures: those (sole traders and partnership) where there is no distinction between the assets of the owners and the business when faced with claims from creditors, and those (private and public limited companies) where the assets of the owners and the business are entirely separate, thereby protecting the personal assets of the owners from the claims of the company’s creditors. Another way of expressing this is that, in the first category, the liability of the owners in ‘unlimited’ whereas, in the second category, it is ‘limited’. The availability of ‘limited liability’ is one of the most important incentives to set up company.
Key statute: Insolvency Act 1986, Section 74(2)(d)
In the case of a company limited by shares, no contribution is required from any member exceeding the amount (if any) unpaid on the shares in respect of which he is liable as a present or past member.
Limited liability contd
This means that the only money for which the shareholders may be pursued is any amount which remains unpaid on any shares which have been bought ‘partly paid’. Therefore, under normal circumstances, even if the company’s debts run to millions of pounds the shareholders cannot be asked to pay more.
In a company limited by guarantee, the amount which members must pay is the sum which they agreed (or ‘guaranteed’ to pay) when the company was incorporated.
The incentive of limited liability
For those wishing to invest in companies, the assurance that their liability will be limited is a powerful incentive as it means that entrepreneurs can form companies safe in the knowledge that, if the company fails, their personal assets will be safe. This can be contrasted with the sole trader or member of a partnership, who may find themselves declared bankrupt as creditors pursue claims against them.
Limited liability - note that..
Although limited liability protects the owners of companies, it does little to help the company’s creditors and customers who, ultimately, bear the losses when the company fails. By contrast, the owners can, effectively, walk away from the debts and then set up a similar company, sometimes from the same premises. Such ‘phoenix companies’ have a clear potential for fraud and there are concerns that it is too easy for incompetent or dishonest business owners to misuse limited liability.
Corporate personality
The concept of limited liability requires a distinction to be made between the assets of the individual shareholder and the assets of the company itself. For the company to be able to own its assets it must have a legal capacity separate from its owners. This is known as corporate personality.
Corporate personality - Key definition
The separate legal status of a registered company which provides it with an identity which is separate from that of its members, shareholders and employees.
Salomon v Salomon & Co Ltd - Facts
Salomon had for many years made boots and shoes as a sole trader before deciding to register the business as a limited company. The vast majority of the shares were held by Salomon and one share each held by six other members of his family. He then sold his business to the company. This was paid for by the company paying cash to Salomon and his family and by secured debenture (i.e. a debt) of £10,000 to Salomon personally. When the company failed, the liquidators argued that the debenture (which would take priority over the other debts) was invalid as Salomon and the company were effectively one and the same and so the debenture represented a debt to himself, which was impossible in law.
Salomon v Salomon & Co Ltd - Legal principle
Held: the House of Lords held that the debenture still took priority over the other debts of the company as it was a separate legal entity, completely distinct from its members. Therefore, it could owe money to its members and, accordingly, the debenture in favour of Salomon was valid. Lord Herschell: ‘It is to be observed that both courts treated the company as a legal entity distinct from Salomon and the then members who composed it, and, therefore, as a validly constituted corporation.
Corporate personality - Tip
Salomon remains the single most important decision in company law. As such, you must be able to explain both the facts and the significance of the case.
By the third time the case was heard, the debenture had been transferred to a third party: however, this was held to be irrelevant. The third party was equally entitled to the security conferred by the debenture.
Effects of corporate personality
Although limited liability is the most important consequence of corporate personality, there are others:
- The company can sue and be sued in its own right.
- The company can be a party to contracts (e.g. to buy and sell goods and to employ staff).
- The company can continue to function after the death of a shareholder.
Macaura v Northern Assurance Co [1925] AC 619 (HL) -
Facts
Macaura sold all of the timber on his estate to a company. He owned almost all of the shares in the company. He insured the timber in his own name but, when the timber was destroyed in a fire, the insurance company refused to pay him, claiming that the timber belonged, not to him, but to the company.
Macaura v Northern Assurance Co - Legal principle
Held: the House of Lords held that the insurance company was correct. The policy would only be valid if the timber belonged to Macaura. However, as it belonged to the company, only the company could insure it. Lord Sumner: ‘It is clear that the appellant had no insurable interest in the timber described. It was not his. It belonged to the company’.
Lee v Lee’s Air Farming Ltd [1961] AC 12 (PC) - Facts
Lee owned all but one of the company’s shares and was a director. He was killed in a work-related accident but the company’s insurers refused to pay compensation as they claimed he could not be an employee of the company. As he owned so much of the company this would amount to him making a contract with himself.
Lee v Lee’s Air Farming Ltd - Legal principles
Held: the House of Lords held that, on the basis of Salomon, there was nothing to prevent the company (as a separate legal entity) from employing Lee. Therefore, his estate was entitled to compensation. Viscount Simonds: ‘The company and the deceased were separate legal entities’.