Analysis Of Separate Legal Personality Principle And Its Application In Employment Contract Breach Cases

George is an employee of Formula Factors, a car garage. His contract of employment provides that if his employment is terminated he cannot directly compete in business with Formula Factors for a period of 6 months. 

George is dismissed from his job and, despite his contract, he wants to start a car garage business straight away. He has heard of the principle of "Separate Corporate Personality" and believes he has found a way around his contract of employment. 

Immediately upon his termination, George decides to set up a company with his son, and that Company runs a garage business in direct competition with Formula Factors. 

George is neither a director nor shareholder of the new company, but he runs the business, and everyone refers to him as "the boss". 

Formula Factors have told George to cease trading or they will go to Court to stop him trading in competition with them and taking their customers. 

George is now worried he doesn't fully understand `Separate Corporate Personality' and looks for your advice. 

Advise George of the law on Separate Corporate Personality and the relevant areas where the Corporate Veil will be lifted. 

Refer in your answer to relevant caselaw and in particular to-the-decision in Salomon -v-Salomon 18971 AC 22 

Separate Legal Personality Principle

Whether Formula Factors has the power to sue George for the breach of his employment contract or whether George can escape by taking the shield of Separate legal entity concept?

When any person intends to initiate any kind of business, then, one of the methods is to incorporate a company. When any business is registered as per the law of the land then it is regarded as a company which has a separate legal personality in law.

Separate legal personality or the separate corporate personality is a principle that was established in the leading case of Salomon v A Salomon & Co. Ltd [1897]. In the leading case, the business which is run by Salomon is in the form of a sole proprietorship. The business is then transferred by him to a company, Salomon Ltd which is incorporated by Salomon himself along with his family members. The transfer was returned to Salomon in the form of shares and debentures. After the failure of the company and upon its liquidation, Salaam was able to seek return based on the secured assets; however, the unsecured creditors were not able to recover anything. The liquidator established that the company must be considered as a sham as the same was incorporated in order to unjust upon the unsecured creditors. The House of Lords submitted that the company formulated by salmon was a distinct entity in law and has its own artificial legal personality. Thus, the acts of Salomon are distinct from the company and the two are separate entities in law. (Ramsay and Noakes 2001)

The concept was retreated in Lee v Lee's Air Farming Limited (1961) wherein it was held that once a company is incorporated it acquires a separate corporate personality in law. The officers of the company are distinct from the company and the acts that are taken by them in the name of the company will hold the company personally liable for the same and no repercussions will fall upon such officers of the company. The separate corporate personality is also analyzed in Farrar v Farrars Ltd., (1888) wherein it was held that the company is distinct personality in law and has the capacity to acquire property in its own name. (Gibson and Fraser 2001)

But, this concept of separate legal personality is not isolated and is attached with the concept of piercing of the corporate veil of the company. It is submitted that when any company is incorporated then it has a separate legal personality in law, but when the incorporation of the company is carried out with the intent to conduct fraud or cheat or sham, then, it was held by the courts in the leading case of Brewarrana v Commissioner of Highways (1973) that in such situation, the corporate legal personality of the company must be disregarded and the distinction that is made amid the officers of the company and the company should not be held justified. In such situations, the acts of the officers which are taken by them in the name of the company must be considered as their own acts and must be held personally liable for the same. In Atlas-Maiitime Co. v. Avalon Maritiine Lt [1991] the court held that to disregard the separate corporate personality of the company and has submitted that the court has the power to look behind the veil of the company and hold the officers liable if any fraud is incurred by them.

Validity of Restraint Clause in Employment Contract

In the leading case of Re Edelsten ex parte Donnelly (Unreported), a fraud is incurred by the officers of the company and the court has disregarded the separate legal personality of the company and lifts the veil and holds the officers liable for the acts that are undertaken in the name of the company. Further, in the leading case of Donnelly v Edelsten (1994), the courts have again pierced the veil of the company and disgraced the separate corporate personality of the company on the incurrence of fraud on the part of the officers of the company.

In Sharrment Pty Ltd v Official Trustee in Bankruptcy (1988), the separate corporate personality of the company was disregarded on the basis that the main reason for the establishing of the company was hidden and mainly was to deceive the other parties and thus the veil must be pierced. Piercing of veil on the ground of façade is also held in the leading case of Peate v Federal Commissioner of Taxation (1964).

Thus, the concept of separate legal personality is a very important concept but the courts are not reluctant to disregard the said concept on the ground that there is some façade or fraud that is incurred by the officers of the company by taking the shield of the concept of separate legal personality of the company.

Now, when any company hires any person then it enters into an employment contract with such person. One of the clause that is made part of such employment clause is the restrain clause according to which the employee is restrain to carry out similar business within some geographical region or for certain time duration after and during the employment. Such clause are valid and is held in Write v Gasweld (1991) it was held in Gilford Motor Co Ltd v Horne [1933] that any incorporation of the company by an employee in order to avoid the effect of the restrain clause is not allowed and the courts are willing to disregarded te corporate personality of the company in such situation. (Hargovan 2006)

The law is now applied to the facts of the case.

As per the facts,

Formula Factors is a car garage. George is an employee at the garage. As per his employment contract, he is not permitted to complete with the business for next six months from the date of his termination.

This is a restrain clause that is made part of the employment contract by Formula Factors. The clause is valid as the same is restraining George for a period of only six months which is a valid period as held in Gilford Motor Co Ltd v Horne [1933].

Piercing the Corporate Veil on the Grounds of Fraud, Sham or Façade

Now, after his termination he intends to start a car garage business despite of the restrain clause made part of his employment contract.  In order to start a business, he established a company along with his son and started pursuing a business which is directly in competition with Formula Factors. George is not the director or the shareholder of the new company but is considered as the boss of the business.

It is submitted that by establishing a company by George along with son, there is a separate legal entity that is established by George. As per the law held in Salomon v Salomon, the company that is established by George along with son is distinct from George himself. Thus, the restrain clause that is imposed upon George by Formula Factors is not applicable on the company as the two of them are distinct legal personalities in law.

But, it is found that the company that is formulated by George along with his son is established mainly to cheat and to incur fraud upon Formula Factors so as to escape the retrain clause that is imposed upon him. As per Donnelly v Edelsten (1994) the courts have disregarded the concept of separate legal entity and has considered that the acts of the officers of the company that are taken in the name of the company should be considered as their personal acts and mist be held them personally liable for the same.

Thus, the incorporation of the company by George along with his son is an act of sham and fraud which is conducted so as to escape from the repercussions of the breach of the restrain clause that is imposed upon him by Formula factors.

Thus, the separate legal entity that makes a distinct amid the company that is incorporated by George and his son must be disregarded that the veil must be pierced making the George personally liable for the acts that are undertaken by the new company.

Thus, the concept of separate legal personality is disregarded and George should be held accountable for the breach of thee restrain clause that is imposed upon him by Formula factors through the employment contract.

Conclusion

It is concluded that the new company formulated by George along with his son should not be considered as a separate legal personality in law as the company is made in order to incur fraud upon the Formula Factors. Thus, the veil that makes the distinction amid the new company and George should be pierced and the acts that are undertaken in the name of the new company must be considered as the acts of the George himself.

Thus, George has violated the restrain clause made part of the employment contract of formula Factors and hence Formula Factors can bring an action against George.

Reference List

Gibson, A & Fraser, D, ‘Business Law 2014’ (Pearson Education Australia, 2013).

Anil Hargovan, (2006) ‘Piercing the Corporate Veil on Sham Transactions and Companies’ 24 Company and Securities Law Journal 436.

Ramsay, I and Noakes D, (2001) ‘Piercing the Corporate Veil in Australia’ 19 Company and Securities Law Journal 250.

Atlas-Maiitime Co. v. Avalon Maritiine Lt [1991]

Brewarrana v Commissioner of Highways (1973).

Donnelly v Edelsten (1994).

Farrar v Farrars Ltd., (1888).

Lee v Lee's Air Farming Limited (1961).

Peate v Federal Commissioner of Taxation (1964).

Re Edelsten ex parte Donnelly (Unreported).

Sharrment Pty Ltd v Official Trustee in Bankruptcy (1988).

Salomon v A Salomon & Co. Ltd [1897].