Author: Monica R Final Year Law Student at Sastra Deemed University
Abstract
The concept of separate legal entity is the fundamental principle of the Companies Act, 2013. The basis of this principle is that company is separate from its shareholders and directors and the exception to this concept is the lifting of corporate veil. If the court thinks that the company and the directors involve in the fraudulent activity the court will lift the corporate veil to protect the interests of the creditors and shareholders. This article will explore the evolution of separate legal entity, exceptions, landmark cases.
Keywords Salomon, Separate legal entity, Lifting corporate veil
Introduction
With the Industrial revolutions and increased trade and commerce activities, regulating the companies has become a mandate. In order to hold defaulters liable for fraud and other negligent acts, it became necessary to identify whom to hold liable. The concept of separate legal entity has been followed from medieval period in European Countries. They considered that companies are separate from their directors and shareholders and companies have separate rights and liabilities. Over the period of time, countries started to codify their laws and principles. This concept gets codified by several countries and followed continuously. With the current rate of the growth and development, it is considered necessary to include this concept to save the investors from unlimited liability.
Separate Legal Entity or Separate Personality
A company is a corporation, so therefore it is a person in the eyes of the law and it is distinct from the individuals who are its members. The company is the separate person, it can hold properties in its own name and it can sell the property and it has perpetual succession. It is not an agent to its shareholders to hold the property and the shareholders cannot sue the company to enforce their rights. The independent legal personality of the company is clearly held in the case of Salomon vs Salomon.
Salomon VS Salomon, 1896
Salomon is a leather merchant in England and carried his business for long period of time. In 1892, he decided to convert it into a limited company and for this purpose Salomon and Co Ltd was formed with Salomon, his wife and 5 of his children as members and Salomon was the managing director. The company purchased the business as going concern for 39000 Pounds. This sum of amount is not a market value, but the reasonable sum which he expects. The price was satisfied as under
Debentures, conferring a charge over all the company’s assets, 10,000 Pounds. Fully paid 1-Pound shares – 20,000 gives 20,000 Pounds.
Totally there are 20,007 shares in the company. Out of which Salomon holds 20.001 shares and his wife holds 1 shares and his 5 children’s hold one share each. The company ran into difficulties and only a year later and then holder of the debentures appointed a receiver and the company went into liquidation. No amount is left to the unsecured creditors, as the assets of the company is used fully to discharge the debts and debentures.
In the circumstances of the case, Court of Appeal held that the whole transaction was contrary to the true intent of the Companies Act and that the company was a mere agent, trustee or nominee for Salomon who remained the real proprietor of the business. As such, he is liable to indemnify the company against its trading debts.
The House of Lords reversed the verdict of the Court of Appeals and decided that the business belongs to the company and not to the Salomon. The House of Lords observed that the rule of separate legal entity does not mention anything about the nature of the holding, whether it need to be independent or there is a need of interest in the company. Lord McNaughten observed that 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.
Since, in the Salomon case, the complete separation of the company and its members has never been doubted and the principle of the company’s separate legal personality has been rigorously applied by the Courts.
This is the landmark case, where the concept of separate legal entity has been upheld. Other important cases in separate legal entity are
Lee vs Lee Air Farming Ltd, 1961
Lee incorporated a company of which he is the managing director. In that capacity, he appointed himself as pilot of the company. While on the business of the company, he was lost in a flying accident. Under the workmen compensation Act, her wife received the compensation amount. In effect of the corporate personality enabled him to be master and servant at the same time. This may be referred as the ‘’veil of the corporation’’.
These two cases are landmark case in determining separate legal entity of the company.
Lifting of Corporate Veil
In general, the courts regard themselves as precluded by Salomon case from treating a company as the agent, trustee or nominee of its members and this is so whether they are interpreting a statute or dealing with judge made law. The Courts after examining the current trends in the ownership of the company, they think it is necessary to introduce an examining mechanism. So, the courts have introduced the concept of lifting of corporate veil. Under this, if the court is of the opinion that on the face of it, if the company and its directors involve in any wrong, which affects the well being of the shareholders then the company and its directors can be made personally liable to it.
John P. Lowry observed that adherence to the Salomon principle will not be doggedly followed where this would cause an unjust result.
In the following grounds, the corporate personality is over looked to find out the reality behind the corporation.
Non- statutory Grounds
Determination of character
It became necessary in occasionally to determine the character of the company. In such a case, the courts mat in their discretion examines the character of persons in real control of the corporate affairs.
For benefit of revenue
If the company involves in any unethical practices like tax evasion, tax avoidance for increasing their revenue, the court can lift the corporate veil to hold the company and directors personally liable.
Fraud or improper conduct
The Companies sometimes involve in illegal and fraudulent activities. The courts will refuse to uphold the separate existence of the company where it is formed to defeat the law, to defraud creditors or to avoid legal obligations.
Company avoiding legal obligations
When the company involve in fraudulent and improper conduct for avoiding legal obligations, the court may lift the corporate veil to hold company and directors personally liable.
Protecting public policy
Following the rules laid down by the government is very important. If the companies involve in offences relating to environmental violations, not following the rules of the government of the government, the court may make the company and directors personally liable.
Statutory Grounds
Failure to comply with requirements of incorporation
When the company fails to comply with the basis requirements of the incorporation like publishing prospectus, Memorandum of Association, Article of Association, the court may lift the corporate veil for the purpose of saving the creditors and shareholders of the company and make the directors and the company personally liable.
Mis – description of name
When the companies use the name which is similar to that of the name of the existing company or describes the name wrongly for the purpose of damaging the reputation of the other company or defaulting the creditors, the company and the shareholders can be made personally liable.
Fraudulent conduct of business
When the company involves in fraudulent trading, deceitful activities, misappropriation of the funds, etc the company and directors can be made personally liable to the affected persons.
Holding and subsidiary companies
When the holding company extends unnecessary control over the subsidiary company, which affects the functioning of the subsidiary company, the court lift the corporate veil.
The courts should apply the concept of corporate veil in the strict manner. Proper evidence should be obtained before applying lifting of corporate veil. Protecting the interest of the shareholders should be the main aim.
Conclusion
The concept of separate entity held in Salomon vs Salomon case is still operating has a pillar of the company law and the concept of lifting of corporate veil and its exception is still considered effective in the modern times. With the evolving business environment, the concepts need to be updated and more rules and exceptions need to be added. The illegal acts cannot be ignored as the company and its directors are distinct. The corporate veil can be lifted to protect the interest of shareholders.
