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Separate Legal Entity Principle

Question:

Whether Chu has violated the restrain clause that is imposed upon him by Computers Pty Ltd (COMPUTERS)?

In Australia, whenever any business needs to be established, then, one of the significant ways is its incorporation which results in the formation of a company. Once a company is formed then it owns a feature of separate legal entity, which symbolizes, that the company is distinct from its members and any action which is undertaken in the name of the company will be binding upon the company alone and will to make any company directors or officers liable for the same.[1]

In Salomon v A Salomon & Co Ltd[2], it was held that a company is an artificial legal entity in the eyes of law and has the capacity to sue or be sued in its own name. It was held in Lee v Lee's Air Farming Ltd[3], that since a company has its own legal personality, thus, the directors/outsiders/members can establish a contract with the company.  In the given case, Lee was the director/shareholders and employee of the company at the same time. Lee died while performing his employment duties. It was held that a single person has the capacity to be the employee and director of the company at the same time but in different capacity. Compensation was provided to the wife of Lee after considering the Lee dies while serving his employment duties. The concept was also applied in Industry v Bottrill[4].[5]

However, this separate legal entity principle can be pierced by lifting the veil when there is presence of agency, fraud, sham or façade, group enterprises and unfairness/justice[6].

The courts are willing to pierce the veil when it believes that there is presence of fraud and the principle lay down in Solomon and Lee will not be applicable. In Gilford Motor Company Ltd v. Horne[7], the Gilford motors is a company and has employed Mr Home. The contract of employment of Mr Home submitted that he is not allowed to solicit the employees of the company after leaving the job. In order to avoid the restrain clause, he established a company in his wife’s name and solicited the customers of Gilford motors. The court held that the intention of formation of new company was to bi-furcate the restrain clause and to incur fraud. Thus, the veil was lifted and it was held that the business carried out by the wife of Mr Home was in fact carried out by him in order to deceive Gilford motors.[8]

Further, every company is managed by its shareholders and directors. Apart from them, employees are also appointed to effectively run a company. These employees do acquire confidential, technical know-hoe and secretive information’s. In order to prohibit these employees from transmitting these information to any other person, restrain clause are made part of their employment agreement[9]. Restrain clauses (non-competent clauses) are clauses wherein no employee is permitted to carry out work in similar trade or work for a certain period of time or at a particular geographical region for  a particular period of time and is analyzed in Write v Gasweld[10].[11]

  1. When the employer wants to protect his genuine or legitimate interest then the restrain clauses can be imposed[12]
  2. When the clause aims at protecting the reputation and goodwill of the company. The company tries to restrict the acts of the employer so that the reputation of the company is not hampered. If the employee indulges him in same trade then the reputation/goodwill of the company is at stake and is held in Stenhouse Australia v Phillips[13].[14]
  • The employer always wants to protect the confidentiality of the business which is at stake if the employer reveals such confidentiality after leaving the business of employer.[15]

Piercing the Veil

However, at times the restrain clause incorporated by the employer is found to be unjustified, that is, when the clause is for a very long duration, then, such clauses are fund to be inappropriate[16]. The long restrain clauses are valid only when the employer can show to the court that the need for long restrain clauses is justified and in the legitimate interest of the employer. The restrain for 1 year or eleven months were held valid[17]. The two year restrain was also held valid in Pearson v HRX Holdings Pty Ltd[18]. If the clauses are against the public policy then the clauses are held to be invalid in nature.[19]

The aggrieved party has the right to seek injunction, damages and compensation for the loss so caused.

Chu was working as operations managers with COMPUTERS for last 5 years. The main purpose of COMPUTERS was to retails computer software and hardware. Chu was at a very senior position and thus he knows the identity of major clients of COMPUTERS. In March 2014, he retired. The COMPUTERS has incorporated a restrain clause in the employment contract of Chu according to which he will not compete against the company in New South Wales for two years.

As per Pearson v HRX Holdings Pty Ltd, the restrain clause that is incorporated by COMPUTERS is valid and is enforceable against Chu. The clause is only for two years and thus is not for a very long time to make it invalid. Also, the clause is required to protect the legitimate interest of COMPUTERS and to maintain its goodwill and reputation in the state.

So, Chu must follow the clause adequately.

But, this restrain clause is very cleverly breached by Chu.

The wife of Chu established a company, Systems Pty Ltd, in which she holds all the issued capital and is the only director. The main aim of the company was selling computer software and hardware. The company was formed in April, a month after Chu retired from COMPUTERS. Also, the area of work is same which is prohibited to be carried out by Chu. By carrying out the similar work, Systems Pty Ltd is soliciting the customers of COMPUTERS in New South Wales. 

Thus, by applying the rule in Gilford Motor Co Ltd v Horne , Chu has established the company in his wife’s name in order to incur fraud on computers.

Though a company established by Chu’s wife has a separate legal entity and must consider Chu’s wife to be distinct from Systems Pty Lt, but, this separate legal entity of the company must be disregarded and the veil must be lifted to consider them as one in order to avoid fraud against COMPUTERS.

Thus, Chu by incurring fraud has violated the restrain clause that is applicable upon him.

Conclusion

To conclude, it can be submitted that the restrain clause that is imposed upon Chu was valid. But, the same was violated by Chu by establishing a company in his wife’s name. Thus, the corporate veil must be pieced and Chu and his wife must not be considered distinct from Systems Pty Ltd.

So, COMPUTERS can sue Chu for injunction, damage and compensation for violating the restrain clause.

References

Books/Articles/Journals

Brown , M, ‘A global guide to ‘restrictive covenants’  (2016)

Duncan, WD, ‘Joint Ventures Law in Australia’ (3rd Edition, Federation Press, 2012).

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

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

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

Case laws

AGA Assistance Australia Pty Ltd v Tokody (2012).

General Billposting Company Ltd v Atkinson [1909] AC 118.

Gilford Motor Co Ltd v Horne [1933] Ch 935

Industry v Bottrill (1999)  .

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

Pearson v HRX Holdings Pty Ltd (2012).

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

Smith v Nomad Modular Building Pty Ltd (2007).

Seven Network (Operations) Limited v Warburton (No 2) (2011).

Stenhouse Australia v Phillips (1974).

Write v Gasweld (1991).

Woolworths Limited V Mark Konrad Olson (2014).

Online Martial

ASIC, ‘Registering not for profit or charitable organisations’ (2014) https://www.asic.gov.au/for-business/starting-a-company/how-to-start-a-company/registering-not-for-profit-or-charitable-organisations/.

The Law Teacher, ‘The Separate Entity principle’ (2017) < https://www.lawteacher.net/free-law-essays/company-law/the-separate-entity-principle.php>.

[1] ASIC, ‘Registering not for profit or charitable organisations’ (2014) https://www.asic.gov.au/for-business/starting-a-company/how-to-start-a-company/registering-not-for-profit-or-charitable-organisations/.

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

[3] Lee v Lee's Air Farming Ltd (1961).

[4] Industry v Bottrill (1999)  .

[5] The Law Teacher, ‘The Separate Entity principle’ (2017) < https://www.lawteacher.net/free-law-essays/company-law/the-separate-entity-principle.php>.

[6] Ian Ramsay and David Noakes, ‘Piercing the Corporate Veil in Australia’ (2001) 19 Company and Securities Law Journal 250.

[7] Gilford Motor Co Ltd v Horne [1933] Ch 935.

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

[9] General Billposting Company Ltd v Atkinson [1909] AC 118.

[10] Write v Gasweld (1991).

[11] WD Duncan, ‘Joint Ventures Law in Australia’ (3rd Edition, Federation Press, 2012).

[12] Woolworths Limited V Mark Konrad Olson (2014).

[13] Stenhouse Australia v Phillips (1974).

[14] Andy Gibson & Douglas Fraser, ‘Business Law 2014’ (Pearson Education Australia, 2013).

[15] AGA Assistance Australia Pty Ltd v Tokody (2012).

[16] Smith v Nomad Modular Building Pty Ltd (2007).

[17] Seven Network (Operations) Limited v Warburton (No 2) (2011).

[18] Pearson v HRX Holdings Pty Ltd (2012).

[19] Mayor Brown , ‘A global guide to ‘restrictive covenants’  (2016)

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