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The Principle of Separate Legal Identity

Discuss about the Cases and Materials in Company Law.

The doctrine of separate legal identity of the company is a basic principle of the law and that is applicable in most parts of the world. In accordance with this principle, the law treats a corporation as a distinct entity that is separate from its members. The rule of the separate identity of a company can be found throughout the company law and there are widespread practical and theoretical implications of this doctrine of company law. In the present assignment, the concept of separate legal identity will be evaluated and at the same time, the decision given Salomon's case will also be examined. However this examination will be made in view of the statement according to which the doctrine of corporate entity is like a boomerang and it can also give back the person who is trying to use it. Therefore, with the above applicable case law, the principle of separate legal identity of company has been evaluated and at the same time, the limits that have been placed on corporate entity have also been examined. Generally it is said that the doctrine of corporate entity is a double-edged sword.

The court had illustrated the doctrine of separate entity in the case titled R v Arnaud (1846). The brief facts of this case are that a registering authority had refused to register a ship due to the reason that some foreigners were among the owners of the ship. The owner of the ship was a British chartered company but its members included some foreigners. In this case, the court made in order that they registering authority should register the ship on the grounds that owner of the ship was the British company instead of members (Farrar, 1998). However the landmark decision related with the principle of separate entity is considered as decision given Salomon v Salomon & Co Ltd (1896).

In this case, the separate identity of the company was confirmed and a company has to be treated as having a distinct legal personality. The very facts of this case are that the Salomon had sold his shoe business to the company that was created by him under the Companies Act. The company was registered under the Act and the members of the company were Mr. Salomon and the members of his family. Particularly, fully paid shares and debentures were received by Mr. Salomon up to the value of ï¿¡10,000 and later on, he assigned them to another party. After some time, the business of the company declined and the company went into insolvency. The liquidators tried to hold Mr. Salomon responsible for the debts of the company and it was argued by them that the transaction was a fraud committed on the creditors of the company and therefore, Mr. Salomon should not be allowed by the law to benefit from the transaction. At the same time, it was also argued by the liquidator that the company was merely an agent of Mr. Salomon and therefore, Mr. Salomon is required to indemnify the company as well as its creditors.

The Decision in Salomon's Case

However while deciding the case, the House of Lords arrived at the decision that the Salomon did not have any liability towards the company nor to its creditors. But in this regard, it needs to be noted that in this case, the House of Lords has not really only decided that Salomon & Co. was a company that has been duly incorporated according to the Companies Act, 1862 (UK) although the seven shareholders of the company were not truly independent. However all the statutory requirements mentioned in this regard have been satisfied as the company had seven shareholders.

In view of the decision given by the House of Lords in this case, the following four points follow from the proposition that the companies that have been duly incorporated, enjoyed a separate legal identity. These are that the property of the company is company's property and similarly the debt of the company is also the debt of the company. Similarly, the company can enter into a contract with its members and outsiders and torts and crimes can be committed by the companies. The above-mentioned four points have been reasserted in a number of cases. Similarly, arguments can be given in favor of as well as against the decision given in Salmon's case. It also needs to be noted that by applying the principle of separate entity, only beneficial effects have been produced for the shareholders however, the application of this principle may result in a disadvantage for the third parties, particularly the creditors of the company (Sealy, 1996). Therefore, in several situations, the courts and the legislature have intervened where the application of the principle of separate entity can be abused or where the application of this principle may result in unjust consequences. This is called the ‘lifting of the corporate veil’.

The application of this principle does not mean that suddenly the company is considered as not being incorporated but the meaning of this principle is that the fact of the incorporation of a company will be ignored by the court in order to decide in certain circumstances that in case of a particular transaction, it has been decided by the court or the legislature that the will not be considered as having a distinct identity (Pennington, 1995). The decision is always difficult for the courts whether to lift the corporate veil in a particular case or not. In such a case, the court has to decide where the loss should lie. As discussed above in Salmon's case and also in Lee v Lee's Air Farming Ltd (1961), if by simply applying the principle of separate entity, may cause extreme results. With the passage of time, the courts have moved away from the strict application of the principle provided in Salmon's case in order to deal with the difficult situations so that they can adopt a more interventionist approach while trying to achieve justice under certain circumstances.

Arguments For and Against the Corporate Entity Principle

On the basis of the above mentioned the decision, it can be said that the courts may decide to pierce the veil of incorporation under the following circumstances. For example in case of a fraud or sham, the court may decide to guess the corporate veil (Adams v Cape Industries Plc., (1990). Such a situation takes place when the principle of separate legal entity has been used by the individuals for doing something which they have personally bound to do. In the same way, the court may decide to pierce the veil if the Court has recognized an agency relationship. When the subsidiary has been treated as an agent of the holding company, the court may be as the veil and in this way, say that the holding company is liable for the debts of the subsidiary. Apart from the two main circumstances that have been mentioned above, the court may also decide to pierce the corporate veil in cases like the evasion of legal obligations or paramount public interest (Gilford Motor Company Ltd v Horne, 1933). Therefore it can be said that the corporate veil can be lifted by the courts and the principle of separate legal entity can be ignored by the records and justice requires the court to do so.

In the end, it can be said that the principal that has been established by the court in Salmon's case can be considered as a double-edged sword. Numerous debates have been going on regarding this principle and therefore the question is also often raised if the positive effects of this principle overweigh the negative effects, has not been answered yet due to the reason that it is far too broad (Jones v Lipman, 1962). However despite facing criticism, it can be said regarding the principle of separate entity that this principle has played an important role in developing modern capitalism and at the same time, this principle has also helped in generating social and economic wealth. At the same time, it can also be said that the principle of separate entity enjoys a very significant position under the company law and this situation should never be changed. 

In certain cases, the circumstances can be quite complex and as a result, if the principle of separate entity is applied strictly, it may result in apparently unfair results. However with a view to defend justice in some cases, the legislature is required to forge a sledgehammer that can crack open the corporate shell. It has also been stated that without a statutory assistance generally the courts have shown their readiness to lift the corporate veil and impose liability on the members and the directors of the corporation. Therefore, the principle of separate legal identity has been ignored by the courts in the number of cases, for example when it is of paramount significance to protect the interests of the public or where the company has been formed only with a view to evade legal obligations.

References

Farrar John H, 1998, Farrar's company law, 4th ed., London: Butterworth.

Pennington Robert R., 1995, Company Law, 7th ed., Butterworths.

Sealy LS, 1996 Cases and Materials in Company Law, 6th ed., Butterworths.

Adams v Cape Industries Plc (1990) Ch 443.

Gilford Motor Company Ltd v Horne [1933] Ch 935.

Jones v Lipman [1962] 1 WLR 832.

Lee v Lee's Air Farming Ltd [1960] UKPC 33.

R v Arnaud (1846) 9 QB 806.

Salomon v Salomon & Co Ltd [1896] UKHL 1.

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