Nature of the Legal Personality Cases Flashcards
Salomon v A Salomon and Co Ltd [1897] AC 22
Introduction
Separate Legal Personality (SLP) is the basic tenet on which company law is premised. Establishing the foundation of how a company exists and functions, it is perceived as, perhaps, the most profound and steady rule of corporate jurisprudence. Contrastingly, the rule of “SLP” has experienced much turbulence historically, and is one of the most litigated aspects within and across jurisdictions.1 Nonetheless, this principle, established in the epic case of Salomon v Salomon,2 is still much prevalent, and is conventionally celebrated as forming the core of, not only the English company law, but of the universal commercial law regime.
Commonly known as: Salomon v Salomon
FACTS IN SALOMON V SALOMON
Salomon transferred his business of boot making, initially run as a sole proprietorship, to a company (Salomon Ltd.), incorporated with members comprising of himself and his family. The price for such transfer was paid to Salomon by way of shares, and debentures having a floating charge (security against debt) on the assets of the company. Later, when the company’s business failed and it went into liquidation, Salomon’s right of recovery (secured through floating charge) against the debentures stood aprior to the claims of unsecured creditors, who would, thus, have recovered nothing from the liquidation proceeds.
To avoid such alleged unjust exclusion, the liquidator, on behalf of the unsecured creditors, alleged that the company was sham, was essentially an agent of Salomon, and therefore, Salomon being the principal, was personally liable for its debt. In other words, the liquidator sought to overlook the separate personality of Salomon Ltd., distinct from its member Salomon, so as to make Salomon personally liable for the company’s debt as if he continued to conduct the business as a sole trader.
ISSUE IN SALOMON V SALOMON
The case concerned claims of certain unsecured creditors in the liquidation process of Salomon Ltd., a company in which Salomon was the majority shareholder, and accordingly, was sought to be made personally liable for the company’s debt. Hence, the issue was whether, regardless of the separate legal identity of a company, a shareholder/controller could be held liable for its debt, over and above the capital contribution, so as to expose such member to unlimited personal liability.
RULING IN SALOMON V SALOMON
The Court of Appeal, declaring the company to be a myth, reasoned that Salomon had incorporated the company contrary to the true intent of the then Companies Act, 1862, and that the latter had conducted the business as an agent of Salomon, who should, therefore, be responsible for the debt incurred in the course of such agency.
The House of Lords, however, upon appeal, reversed the above ruling, and unanimously held that, as the company was duly incorporated, it is an independent person with its rights and liabilities appropriate to itself, and that “the motives of those who took part in the promotion of the company are absolutely irrelevant in discussing what those rights and liabilities are”.3 Thus, the legal fiction of “corporate veil” between the company and its owners/controllers4 was firmly created by the Salomon case.
IMPLICATIONS OF SALOMON V SALOMON
Commencing with the Salomon case, the rule of SLP has been followed as an uncompromising precedent5 in several subsequent cases like Macaura v Northern Assurance Co.6, Lee v Lee’s Air Farming Limited,7 and the Farrar case.8
The legal fiction of corporate veil, thus established, enunciates that a company has a legal personality separate and independent from the identity of its shareholders.9 Hence, any rights, obligations or liabilities of a company are discrete from those of its shareholders, where the latter are responsible only to the extent of their capital contributions, known as “limited liability”.10 This corporate fiction was devised to enable groups of individuals to pursue an economic purpose as a single unit, without exposure to risks or liabilities in one’s personal capacity.11 Accordingly, a company can own property, execute contracts, raise debt, make investments and assume other rights and obligations, independent of its members.12 Moreover, as companies can then sue and be sued on its own name, it facilitates legal course too.13 Lastly, the most striking consequence of SLP is that a company survives the death of its members.14
The Exception of Veil Piercing
Notably, similar to most legal principles, the overarching rule of SLP applies with exceptions, where the courts may look through the veil to reach out to the insider members, known as “lifting or piercing of the corporate veil“.15
It is worthwhile here to refer to the case of Adams v Cape Industries16, which examined the common law grounds, primarily evolved through case law as an equitable remedy,17 namely- (a) agency, (b) fraud, (c) façade or sham, (d) group enterprise, and (e) injustice or unfairness. The exception has been invoked widely by English courts, including in the recent cases of Caterpillar Financial Services (UK) Limited v Saenz Corp Limited, Mr Karavias, Egerton Corp.18, Beckett Investment Management Group v Hall,19 Stone & Rolls v Moore Stephens,20 and Akzo Nobel v The Competition Commission,21 to cite a few. Needless to mention, the journey of English law in defining the contours of the SLP doctrine and carving out these exceptions has been quite topsy-turvy. Moreover, veil piercing is now also rampant as a statutory exception.22
So, considering the gamut of statutory and judge made exceptions above, has the Salomon rule become redundant?
March back to the Salomon rule
While the Salomon rule appears to have been eroded substantially, a reversal in the judiciary’s approach, commencing with the Adams case, is now visible.
For instance, in Bank of Tokyo v Karoon,23 the Court of Appeal rejected the “single economic unit” theory arguing that “we are concerned not with economics but with law. The distinction between the two is, in law, fundamental and cannot here be abridged”. Further, in the case of VTB Capital Plc v Nutritek International Corporation,24 the court reiterated the restricted scope of veil piercing as only a limited equitable remedy.
On a similar note, in the most recent judgment of Prest v Petrodel25, Sumption J. confined the lifting of veil to only two situations, namely, (a) the “concealment principle”, akin to the sham or façade exception; and (b) the “evasion principle”, being the fraud exception.26 Deciding not to pierce the corporate veil on the facts, this case once again reinstated the Salomon rule.
Conclusion
All in all, the Salomon ruling remains predominant and continues to underpin English company law. While sham, façade and fraud primarily trigger the invocation of the veil piercing exception in limited circumstances, these grounds are not exhaustive, and much is left to the discretion and interpretation of the courts on case-to-case basis.
Macaura v Northern Assurance Co [1925] AC 619
The owner of a timber estate sold all the timber to a company which was owned almost solely by him. He was the company’s largest creditor. He insured the timber against fire, but in his own name. After the timber was destroyed by fire the insurance company refused the claim.
The House of Lords held that in order to have an insurable interest in property a person must have a legal or equitable interest in that property. The claim failed as “the corporator even if he holds all the shares is not the corporation… neither he nor any creditor of the company has any property legal or equitable in the assets of the corporation.” (per Lord Wrenbury, at pg 633).
Lee v Lee’s Air Farming [1961] AC 12
CONCEPT OF SEPARATE LEGAL ENTITY
Companies act, 2013 mentions following features of a company incorporated under the act:
- Separate Legal Entity
- Perpetual Succession
- Limited Liability
- Common Seal
- Separate property
As per Companies Act, 2013 Separate legal entity means that a company which is registered under this act as Non profit organization , private limited company, public company , government company and chit fund company shall have legal identity of its own and will have rights under law and will treated as separate entity from its shareholder. It can own property in its own name and can enter into contracts with other person and can represent itself in court of law through its representative.
Separate legal entity also act as veil between company and its member. Which means that assets of the company shall be used only for the objective of the company as set in Memorandum of association and its liabilities should be paid by itself and not from personal asset of the member of the company.
FACTS OF THE CASE
In 1954 the appellant’s husband Lee formed the company named LEE’S AIR FARMING LTD. for the purpose of carrying on the business of aerial top-dressing with 3000 thousand share of 1euro each forming share capital of the company and out of which 2999 shares were owned by Lee himself. Lee was also the director of the company. He exercised unrestricted power to control the affairs of the company and made all the decision relating to contracts of the company. Company entered into various contract with insurance agencies for insurance of its employees and few premiums of the policies were paid through companies bank account for the personal policies taken by Lee in its own name but it was debited in the account of lee in companies book. Lee apart from being the director of the company was also a pilot. In March, 1956, Lee was killed while piloting the aircraft during the course of aerial top-dressing. Lee’s wife who is appellant claimed worker compensation under New Zealand Workers’ Compensation Act, 1922 as she claimed that Lee during work as employee of the company. The New Zealand Court of Appeal declined the claim of appellant as it refused to hold that Lee was a worker, holding that a man could not in effect, employ himself.
CONCLUSION
This judgement is a very important with respect to U.K company law and Indian Companies act as it lays the precedent that Company is separate legal entity and it can enter into contract with its own member as both are separate legal entity. Concept of separate legal entity was first introduced I Salmon vs Salmon co. ltd. Separate legal entity is a double sided sword as it can be used in bad faith also by interested stake holder to hide behind corporate veil that it provides between the company and its member.
There has been case law where concept of separate legal entity has been refused by court as in the case of Gilford Motor Co V Horne where court lifted the corporate veil and treated the respondent and his company as one entity to assure the validity of the contract that appellant had with respondent. Also in case of insolvency the concept of separate legal entity doesn’t apply and company and its member are treated as one entity.
Barings plc (In Liquidation) v Coopers & Lybrand (No.4) [2002] 2 BCLC 364
Barings PLC (in liquidation) & Anor v Coopers & Lybrand (A Firm) & Ors (2001)
Summary
The claimant, in an action for negligent misstatement, had to plead the circumstances on the basis of which it alleged that the defendant knew of the intended transaction of the claimant and its reliance on the defendant for that purpose. A subsidiary auditor was not to be treated as subject to the same duties to a parent company as those to which the group auditor would be subject as a result of its contractual relationship with that parent.
Facts
Application by Deloitte & Touche (Singapore) (‘DT’) to strike out the claims for negligent misstatement brought against them by Barings plc (‘PLC’) and Bishopscourt (BS) Ltd, formerly Barings Securities Ltd (‘BSL’) in the combined action against the auditors resulting from the collapse of the Barings group in 1995. DT were the auditors of Barings Futures Singapore Pte Ltd (‘BFS’) in 1992 and 1993 and were replaced by Coopers & Lybrand Singapore (‘CLS’) in 1994. Coopers & Lybrand in London (‘CLL’) audited PLC, BSL and the Barings group in all three years. A preliminary issue was to be held in the BFS action as to whether DT had a complete defence based on circuity of action and/or set-off and/or estoppel, arising from director’s representation letters signed during the audits, such as to bar BFS’ claim. The trial of the combined action began on 2 October 2001 and during its second week it was announced that the claimants had signed settlement agreements with the Coopers firms. There were three categories of claim brought by PLC and BSL and which DT sought to have struck out. (i) BSL claimed, consequent upon the 1992 audit, the sums which it advanced to BFS by way of “dollar funding”. DT argued that this claim failed, both because this was loss which would be made good if BFS were to recover it (the Johnson v Gore Wood (2001) 2 WLR 72 ground) and because on the pleadings, the claim failed the purpose or transaction test in Caparo v Dickman (1990) 2 AC 605. (ii) PLC and BSL both claimed the value of their respective groups, which became insolvent following the collapse. Both claims would lapse if the settlement with the Coopers firms became operative. DT argued that, on the pleading, the loss of value claims failed the purpose or transaction test. (iii) PLC claimed (consequent upon the 1993 audit) in relation to bonuses which it paid out in 1994, the calculation of which relied on the apparent 1993 profits shown in the 1993 accounts. The profits were overstated in that they failed to take account of Nick Leeson’s losses on the 88888 account. DT applied to strike it out on the facts and on the Johnson v Gore-Wood ground.
Held
(1) To perfect his cause of action for negligent misstatement a claimant must establish that the defendant had in contemplation the transaction by which the claimant suffered loss in order for the defendant to have assumed a duty to exercise due care and skill to protect the claimant from the loss resulting from it. To have in contemplation might mean either to be directly informed that the claimant either would or was likely to embark on the transaction in reliance on his advice or other statement or that, from the surrounding circumstances of the case, it could be inferred that he knew of the transaction and the reliance (Caparo (supra)). (2) It was clear that the claimant must plead the circumstances on the basis of which he alleged that the defendant knew of the intended transaction of the claimant and his reliance on the defendant for the purpose of it (Caparo (supra) and Galoo Ltd v Bright Grahame Murray (1994) 1 WLR 1360). (3) The dollar funding loans started some 15 months after DT’s consolidation schedules were sent to CLL and the transactions which brought down the Barings Group occurred approximately two years later. It was hard to see how BSL could allege the necessary reliance on DT’s 1992 audit to comply with the purpose test in respect of the dollar funding loans. (4) DT could not be treated as if it had a contractual relationship with BSL at the material time of the audit, because of Barings’ company structure at the time, thereby rendering it liable to all the consequences of failing to discover the Leeson frauds in the course of the 1992 audit, without the limitation arising as a result of the application of the purpose test. BCCI v Price Waterhouse (1998) Lloyd’s Rep 85 was not authority for the proposition that a subsidiary auditor was to be treated as subject to the same duties to a parent company as those to which the group auditor would be subject as a result of his contractual relationship with that parent. (5) DT was not bound by the results of earlier proceedings in this litigation concerning the Coopers firms. (6) Both the dollar funding claims and the loss of value claims failed the purpose test in that the statement of claim did not adequately plead them. (6) The Johnson v Gore-Wood defence did not therefore arise but the judge held that DT’s entitlement to set off its claim for deceit against BFS’ claim against them for negligence was not a circumstance which permitted BSL as a shareholder of BFS to sue for reflective loss. BSL’s claim for its dollar funding was reflective. For this reason also, the dollar funding claim disclosed no reasonable cause of action and should be struck out. (7) No decision could be given on the applicability of the Johnson v Gore-Wood defence to the overpaid bonuses before the trial. As pleaded, in the light of the undisputed facts, the claim had no prospect of success and the current pleading would be struck out under the court’s inherent jurisdiction.
Application granted.
Giles v Rhind [2003] 2 WLR 237
Giles v Rhind [2003] concerns personal claims for damages when the company is unable to pursue its own action.
Keywords:
Company law – Shareholders – Shareholders’ agreement – insolvency – Personal claim for damages – Court of Appeal – Appeal allowed
Facts:
In the present case, the claimant, Edward John Giles, and the defendant, Roderick Middleton, were former shareholders of a company. The latter had become insolvent after the defendant had diverted a lucrative contract to a third party in breach of a shareholders’ agreement. As a result of insolvency, the company terminated its action against the defendant. However, the claimant, Edward John Giles, sought to pursue his own action damages against the defendant, Roderick Middleton. The claimant sought the loss in value of his shares and future earnings as well.
Issue:
Whether Edward John Giles was entitled to pursue his own personal claims against the defendant?
Held:
The Court of Appeal allowed the appeal. It held that Edward John Giles was entitled to pursue his personal claims against the defendant, separate from that of the company. In any case, the claimant could proceed with his personal claims as the company could not to pursue its own action as a result of Roderick Middleton’s wrongdoing.
The court of appeal distinguished the present case from Johnson v Gore Wood. In the latter case, since the company was able to pursue its own action, the court barred the additional claim brought by the member of the company.
Shaker v Al-Bedrawi [2003] 2 WLR 922
Hashem v Shayif [2008] EWHC 2380 (Fam).
Although both the ‘husband’ and the ‘wife’ had known that the couple’s marriage was bigamous at the time of the ceremony, at the end of the relationship the ‘wife’ sought ancillary relief from the court. The husband was resident in Saudi, and refused to participate meaningfully in the ancillary relief process. The wife argued that the English court could treat the property she had been living in, and another investment property, as beneficially owned by the ‘husband’, although legally owned by a family company whose shares were distributed between the ‘husband’ and his children. The company issued proceedings in the Chancery Division, seeking a possession order and declarations that the company owned the relevant property. The two sets of proceedings were consolidated.
The ‘wife’ had failed in her claim against the company and the children, except in as much as she had established that the company could not remove her from the property she was living in without giving her notice. Mubarak v Mubarak [2001] 1 FLR 673 was not authority for the proposition that impropriety was not an essential requirement of piercing the veil of incorporation. In all cases in which the court had been willing to pierce the veil, the company had been being used by its controller in an attempt to immunise himself from liability for some wrongdoing that existed entirely outside the company. However, the ‘wife’ had succeeded in her claim against the ‘husband’ for a lump sum of £7,061,570, including an order for the transfer to her of the husband’s company loan account. She was entitled to ancillary relief even though the marriage had been bigamous; in this case the impact of the bigamy was marginal. Neither the ‘husband’ nor the ‘wife’ had been deceived as to the status of the marriage, and the contemporaneous religiouis marriage had been valid.
