Overview And Legal Principles Of Electric Light And Power Supply Corporation Limited

Doctrine of Separate Legal Entity

Discuss about the Electric Light and Power Supply Corporation Limited.

The legal notion and definition of a company has undergo tremendous change with time as modifications have been made to both legislative and judicial definition of a company. In the judicial interpretation of a company and the following statutes, one case that manages to stand out is the Saloman v Saloman & Co Ltd 1897 AC 22 (hl). This case can be considered as the founder of the modern company law as it established one of the central tenets which resolve about the limited liability of the company which is essentially a separate legal entity different from the underlying owners. Before reflecting on the key principles identified in the Solomon case, it is worthwhile to revisit some relevant facts of this historic case (Forji, 2007).

Aron Solomon operated his merchant business under the sole proprietor business structure and dealt with leather boots manufacturing. Since, his son took keen interest in the business, he changed the business structure to a limited company which was named Salomon & Co. Ltd.  At the time, a limited company required atleast seven members or shareholders. As a result, Solomon formed a company with a total of 20,007 shares out of which 20,001 were owned by Solomon and the remaining six shareholders (i.e. his spouse and children) held one share each. The business was sold for a consideration of £39,000 which included a debt payable to Solomon to the tune of £10,000. Thus, this represented an interesting situation where the main shareholder also was acting as the primary creditor.The liquidators later argued that the underlying debentures issued to secure the debt were not valid and hence Solomon was accused of committing a fraud (Cassidy, 2007).

The matter landed in court with the court ruling that company creation was to facilitate business transfer only and hence it is an agent for the principal (Solomon), thus holding him liable to pay the outstanding debt of unsecured creditors. The Court of Appeal (CoA) also endorsed the stance taken by the court advocating that company structure was only a means to ensure business activities could be conducted while ensuring protection under limited liability clause available under a company(Harris, 2014).. But the decision taken by the CoA was quashed by the House of Lords which reflected on the literal interpretation of 1862 Companies Act and opined that the act does not have any condition for the minority shareholders and the majority shareholders to be independent of each other(Harris, 2015). Further, it was also opined that judges should not reflect upon the statute limitations and instead implement the same in their existing form. Thus, this verdict in the Solomon case clearly established that the corresponding rights and obligations for members in respect of shares is limited to only the profit share and investment of capital respectively (Parker et. al., 2012).

It is apparent from the above case verdict that one central tenet that this case developed was that the company needs to be considered as a separate legal which is distinguished from the owners or shareholders and thus particular rule has stood the test of time and in relation to the Anglo-Saxon courts continues till the present day. Since the company is an independent entity, hence for the various actions and decision, only it would be held responsible and not the corresponding agents. This has been highlighted in the Gas Lighting Improvement Co Ltd v Inland Revenue Commissioners [1923] AC 723where Lord Sumner delivered the following commentary (Baxt, Fletcher & Friedman, 2008).

Theoretical Basis – Separate Legal Entity

“Between the investor, who participates as a shareholder, and the undertaking carried on, the law interposes another person, real though artificial, the company itself, and the business carried on is the business of that company, and the capital employed is its capital and not in either case the business or the capital of the shareholders. Assuming, of course, that the company is duly formed and is not a sham…the idea that it is mere machinery for affecting the purposes of the shareholders is a layman’s fallacy. It is a figure of speech, which cannot alter the legal aspect of the facts.”

A case in the Australian context which reaffirms the above principle is the MacLaine Watson & Co Ltd v Department of Trade and Industry [1989] 3 All ER 523 case in which it was opined that a key aspect which has contributed to the creation of logical symmetry in industrial feudalism is that the various industrial enterprises need to be treated as legal entities akin to individuals. This principle has immense support both from the legislators but also from the judges in various nations that follow the Anglo-Saxon system (Australia being one of them). Consequently, this principle has been explicitly outlined in Corporations Act 2001 in the Section 124 and thus providing it statutory backing. Further, even since the Solomon case, this particular doctrine has received quite an immense support from the judges based on Australian and UK who tend to apply this quite widely (Cassidy, 2013).

Another doctrine established by this case is that the liabilities of shareholders in accordance with common law is limited to the only the capital investment made initially and thus these must not be held liable for any debts outstanding or defaulted by the company. This principle has been endorsed in the The King v Portus; ex parte Federated Clerks Union of Australia [1949] HCA 53; 79 CLR 428case where the judge opined that the as the company and the owners are two different entities and hence the obligations arising from the actions taken on the name of the company would have to be directly borne by the company only and not be the shareholders or employees (Li and Riley, 2009).

Considering the wide application and popularity of the personification of the company, it makes sense to critically analyze the theoretical and practical basis for the same which hints at the underlying usefulness of this concept.  The various theories dealing with corporate entity tend to extend the need that companies must be given artificial personality for practical reasons.  The concession theorists opine that the state has given a privilege in the form of corporate personality which tends to enhance the overall convenience in business and legal terms (Pathinayake. 2014). The contractarian viewpoint in this regard debates that there is a reduction in transaction costs brought about by the corporation law as the underlying corporate charter tends to provide for all those rights which a reasonable shareholder would insist on. This understanding forms the very basis of corporate law and is endorsed by various aggregate theorists, Together these theorists are extremely appreciative of the critical part that the Salomon principle plays in identification of corporation as a legal entity and thus providing it with the power to enter into contractual relationship with the outsiders for the performance of business activities (Forji, 2007).

Practical Basis – Separate Legal Entity

The utility of the Solomon principle is not limited to the theoretical underpinnings but is equally endorsed by the practitioners of the corporate law. It is imperative that providing the company a legal entity and distinguishing the same from the shareholders serves a crucial function of ensuring the business is not constructed around human beings(Cirto & Symes, 2013). The main reason for this that the duration of the human being typically is limited and short unlike that of the organizations which are potentially set up to survive till eternity and thus are permanent in nature. In line with s. 124, a company is essentially an artificial person and thus the underlying form is metaphysical and not physical (Parker et. al., 2012). Further, law has also permitted the company to perform various functions that an individual could have performed such as entering into contracts, taking loans and being responsible to the various parties for the conduct. The only difference is that while an individual can perform the above functions on his/her own while the same is not feasible for a company which takes and enacts decisions through the agents which refer to the management and employees (Lipton, 2015). The various powers of the company along with the relevant cases are as listed below (Forji, 2007).

• Power to sue a particular party and to be sued by other (Foss v Harbottle (1843) 67 ER 189)
• Continuous and perpetual succession for the corporation (Regal (Hastings) Ltd v Gulliver [1942] UKHL 1)
• Power to execute contracts with various parties (Macaura v Northern Assurance Co Ltd. [1925] AC 619)

Additionally, limited liability upheld through Solomon principle ensures the minimization of costs associated with control and ownership separation. This is because under the limited liability of shareholders and stakeholders, there is a reduced need to monitor the various shareholders along with the management. Also, the transfer of shares in the entity facilitated by limited liability tends to act as an potent management incentive for improving upon their performance. Further, through the aegis of limited liability, shares become tradable and marketable which owing to increased trading and corresponding market transactions leads to better information sharing about the financial performance and corporate decision making. Besides, diversification of share holdings is also made possible through limited liability (Lipton, 2015).

While the above discussion highlights the utility of the Solomon principles in reality, however, the verdict also has faced criticism from various quarters. In wake of these concerns, it is imperative that the Solomon principle need not be applied rigidly but with enough flexibility so as not to shield the parties with wrong intentions.  If the legal personification of company is applied without taking into consideration the case facts and the underlying intent of the shareholders, it is quite possible that the demerits of this clause may outweigh the various merits identified above. As a result, in limited circumstances the courts tend to keep aside the immunity offered by limited liability and tend to pierce the corporate veil so as to fix the accountability of the actions taken in the name of the company by the relevant shareholders or management personnel (Baxt, Fletcher & Fridman, 2008).

There are various circumstances in which the Solomon principle may be overlooked. One of these is fraud which takes place in cases when the shareholders take to company formation only as a means to bypass the legal or fiduciary obligations which it already owed to the various parties particularly creditors (Cassidy, 2013). A relevant case in this regard is the Re Edelsten ex parte Donnelly (1998) 18 FCR 434case whereby the court had to decide if corporation formation was prompted with the sole motive of denying payments to the creditors taking the shield of limited liability. The general accepted principle is that higher conspicuousness associated with the sham tends to increase the possibility of the court ruling that there has been fraud. The honorable judge opined the following in this case (Forji, 2007).

“The argument of fraud is, of course circular. It can only succeed if the argument ofsham succeeds, because if no property was acquired by, or devolved upon, Edelsten, no duty capable of being evaded could arise under the Act…The submission that the VIP Group had been used to perpetrate a fraud was coincident, and stood, or fell, with the submissions which sought to have the transactions, by which the VIP Group acquired property, treated as shams.”

For separate legal entity principle to be upheld, it is essential that the entity formed as a company should not be a mere agent for the shareholders acting in the capacity of the principal. In such cases, it is quite possible that the corporate veil may be pierced by the court in order to determine the true centre of control.  This was the case in Barrow v CSR Ltd in which the court realized that the subsidiary firm was under the complete and direct control of the parent firm and hence lifted the corporate veil. The court argument is summarized below (Forji, 2007).

“Now, whether one defines all of the above in terms of agency, and in my view it is, or control, or whether one says that there was a proximity between CSR and the employees of ABA, or whether one talks in terms of lifting the corporate veil, the effect is, in my respectful submission, the same.’’

However, there is reluctance on the part of the courts to apply the same in case of small companies as is apparent from the verdict of the Ampol Petroleum Pty Ltd v Findlay case. Besides, where a judicial question is involved to ascertain whether any agency relationship was present or not, the court tend to be a little reluctant in piercing the veil as is apparent from The Electric Light and Power Supply Corporation Limited v Cormack (1911) 11 NSWSR 350 case (           Pathinayake, 2014).

Another ground on which the corporate veil may be lifted is with regard to cases where the court is of the opinion the veil lifting would help in bringing about a more fair and just decision as highlighted in the RMS Glazing Pty Ltd v The Proprietors of Strata Plan No 14442  case. Further, veil lifting is also done in cases of group enterprises where it may not be possible to distinguish between the parent firm and the subsidiary as highlighted in the Bluecorp Pty Ltd v ANZ Executors and Trustee Co Ltd (supra) (1995) 18 ACSR 566 case (Lipton, 2015).

Conclusion

Thus, it may be concluded from the above discussion that the principles laid down in the Solomon case laid the foundation of modern company law and continue to have immense utility even after more than a century has passed away. However, owing the fraudulent use of this principle in order to minimize their liability or to put disproportionate risk burden on the end of the creditors and lenders, it is essential that courts need to maintain a delicate equilibrium so that the shareholders do not indulge in frivolous use of the protection provided. In this regard, it would not be prudent to include this into any statute but rather let the courts decide on the basis of the individual merits of the case.  Also, the corporate veil lifting is in a transition stage in most of the Anglo Saxon jurisdictions and it is expected that the English and Australian courts would prove to be an apt harbinger in this regard and lead by example that could be considered as precedents.

References

Baxt, R., Fletcher, K.L. & Fridman, S. (2008). Corporations and Associations Cases and Materials (10^th ed.). Butterworths: LexisNexis Australia.

Cassidy, J. (2013). Corporations Law Text and Essential Cases (4^th ed.). Sydney: Federation Press.

 Ciro, T. & Symes, C. (2013). Corporations Law in Principle (9^th ed.). Sydney: LBC Thomson Reuters.

Fisher, S. Anderson, C. & Dickfos, (2009). Corporations Law - Butterworths Tutorial Series (3^rd ed.). Butterworths, Sydney: LexisNexis Australia.

Forji, A.G. 2007, The Veil Doctrine in Company Law, LLRX Website, [Online] Available at https://www.llrx.com/2007/09/the-veil-doctrine-in-company-law/ [Accessed April 24, 2017]

Harris, J. (2014). Corporations Law (2^nd ed.). Sydney: LexisNexis Study Guide.

Harris, J., Hargovan, A. & Adams, M. (2015). Australian Corporate Law (5^th ed.). Melbourne: LexisNexis Butterworths Australia. 

Li, G. & Riley, S. (2009). Applied Corporate Law: A Bilingual Approach (1^st ed.). Sydney: LexisNexis Australia.

Lipton, P. 2015 The Mythology of Salomon’s Case and the Law Dealing with the Tort Liabilities of Corporate Groups: An Historical Perspective, Monash University Law Review, Vol. 40 No.2, pp. 452-487

Parker, Clarke, Veljanovski, & Posthouwer, (2012). Corporate Law (1^st ed.). South Yarra : Palgrave Machmillan

Pathinayake, A. (2014). Commercial and Corporations Law (2^nd ed.). Sydney :Thomson-Reuters.

Bluecorp Pty Ltd v ANZ Executors and Trustee Co Ltd (supra) (1995) 18 ACSR 566

Foss v Harbottle (1843) 67 ER 189

Gas Lighting Improvement Co Ltd v Inland Revenue Commissioners [1923] AC 723

Macaura v Northern Assurance Co Ltd. [1925] AC 619

MacLaine Watson & Co Ltd v Department of Trade and Industry [1989] 3 All ER 523

Re Edelsten ex parte Donnelly (1998) 18 FCR 434

Regal (Hastings) Ltd v Gulliver [1942] UKHL 1

RMS Glazing Pty Ltd v The Proprietors of Strata Plan No 14442

Saloman v Saloman & Co Ltd 1897 ac 22 (hl)

The Electric Light and Power Supply Corporation Limited v Cormack (1911) 11 NSWSR 350

The King v Portus; ex parte Federated Clerks Union of Australia [1949] HCA 53; 79 CLR 428