Friday, September 26, 2008
THE DOCTRINE OF CORPORATE PERSONALITY
Hello there my dear students.Today I want to touch on the doctrine of corporate personality.In this chapter we explore the related concepts of corporate legal personality and limited liability. These concepts are central to your developing an understanding of company law and it is essential that you take time here to absorb these fundamental principles.
Corporate personality refers to the fact that as far as the law is concerned a company personality really exists apart and different from its owners. As a result of this, a company can sue and be sued in its own name, hold its own property and crucially – be liable for its own debts. It is this concept that enables limited liability for shareholders to occur as the debts belong to the legal entity of the company and not to the shareholders in that company.
The history of corporate personality
Corporate legal personality arose from the activities of organisations such as religious orders and local authorities which were granted rights by the government to hold property and sue and be sued in their own right and not to have to rely on the rights of the members behind the organisation. Over time the concept began to be applied to commercial ventures with a public interest element such as rail building ventures and colonial trading businesses. However, modern company law only began in the midnineteenth century when a series of Companies Acts were passed which allowed ordinary individuals to form registered companies with limited liability. The way in which corporate personality and limited liability link together is best expressed by examining the key
Salomon v Salomon & Co.
Salomon v Salomon & Co.  AC 22, this assumption proved to be mistaken.
Mr Salomon carried on a business as a leather merchant. In 1892 he formed the company Salomon & Co. Ltd. Mr Salomon, his wife and five of his children held one share each in the company. The members of the family held the shares for Mr Salomon because the Companies Acts required at that time that there be seven shareholders. Mr Salomon was also the Managing Director of the company. The newly incorporated company purchased the soletrading leather business. The leather business was valued by MrSalomon at £39,000. This was not an attempt at a fair valuation; rather it represented Mr Salomon’s confidence in the continued success of the business. The price was paid in £10,000 worth of debentures (a debenture is a written acknowledgement of debt like a mortgage – see Chapter 7) giving a charge over all the company’s assets (this means the debt is secured over the company’s assets
and Mr Salomon could, if he is not repaid his debt, take the company’s assets and sell them to get his money back), plus £20,000 in £1 shares and £9,000 cash. Mr Salomon also at this point paid off all the sole trading business creditors in full. Mr Salomon thus held 20,001 shares in the company, with his family holding the six remaining shares. He was also, because of the debenture, a secured creditor.
However, things did not go well for the leather business and within a year Mr Salomon had to sell his debenture to save the business. This did not have the desired effect and the company was placed in insolvent liquidation (i.e. it had too little money to pay its debts) and a liquidator was appointed (a court appointed official who sells off the remaining assets and distributes the proceeds to those who
are owed money by the company, see Chapter 16). The liquidator alleged that the company was but a sham and a mere ‘alias’ or agent for Mr Salomon and that Mr Salomon was therefore personally liable for the debts of the company.
The Court of Appeal agreed, finding that the shareholders had to be a bona fide
association who intended to go into business and not just hold shares to comply with the Companies Acts. The House of Lords disagreed and found that:
the fact that some of the shareholders are only holding shares as a technicality was irrelevant; the registration procedure could be used by an individual to carry on what was in effect aone-man business a company formed in compliance with the regulations of the Companies Acts is a separate person and not the agent or trustee of its controller. As a result, the debts of the company were its own and not those of the members. The members’ liability was limited to the amount prescribed in the
Companies Act – i.e. the amount they invested. The decision also confirmed that the use of debentures instead of shares can further protect investors.
Read Salomon v Salomon & Co. (1897) AC 22.
(a) Describe the key effects of the change in status from a sole trader to a limited
company for Mr Salomon.
(b) What are the key principles that we can draw from the case?
(c) Should Mr Salomon have been liable for the debts of the company?
In Macaura v Northern Assurance Co.  AC 619
Mr Macaura owned an estate and some timber.He agreed to sell all the timber on the estate in return for the entire issued share capital of Irish Canadian Saw Mills Ltd. The timber, which amounted to almost the entire assets of the company, wasthen stored on the estate. On 6 February 1922 Mr Macaura insured the timber in his own name. Two weeks later a fire destroyed allthe timber on the estate. Mr Macaura tried to claim under theinsurance policy. The insurance company refused to pay outarguing that he had no insurable interest in the timber as the timber belonged to the company. Allegations of fraud were also made against Mr Macaura but never proven. Eventually in 1925 theissue arrived before the House of Lords who found that:
The timber belonged to the company and not Mr Macaura Mr Macaura, even though he owned all the shares in the company, had no insurable interest in the property of the
company just as corporate personality facilitates limited liability by having the debts belong to the corporation and not the members, it also means that the company’s assets belong to it and not to the shareholders.
More modern examples of the Salomon principle and the Macaura problem can be seen in cases such as Barings Plc (In Liquidation) v Coopers & Lybrand (No.4)  2 BCLC 364. In that case a loss suffered by a parent company as a result of a loss at its subsidiary (a company in which it held all the shares) was not actionable by
the parent – the subsidiary was the proper plaintiff.
In essence you can’t have it both ways – limited liability has huge advantages for
shareholders but it also means that the company is a separate legal entity with its own property, rights and obligations.
In Lee v Lee’s Air Farming  AC 12.
Mr Lee incorporated a company, Lee’s Air Farming Limited, in August 1954 in which he owned all the shares. Mr Lee was also the sole ‘Governing Director’ for life. Thus, as with Mr Salomon, he wasin essence a sole trader who now operated through a corporation.Mr Lee was also employed as chief pilot of the company. In March,
1956, while Mr Lee was working, the company plane he was flying stalled and crashed. Mr Lee was killed in the crash leaving a widow and four infant children.The company as part of its statutory obligations had been paying an insurance policy to cover claims brought under the Workers’Compensation Act. The widow claimed she was entitled to compensation under the Act as the widow of a ‘worker’. The issue
went first to the New Zealand Court of Appeal who found that he was not a ‘worker’ within the meaning of the Act and so no compensation was payable. The case was appealed to the Privy Council in London. They found that: the company and Mr Lee were distinct legal entities and therefore capable of entering into legal relations with one another as such they had entered into a contractual relationship for
him to be employed as the chief pilot of the company he could in his role of Governing Director give himself order as chief pilot. It was therefore a master and servant relationship and as such he fitted the definition of ‘worker’
under the Act. The widow was therefore entitled to
Separate legal personality and limited liability are not the same thing. Limited liability is the logical consequence of the existence of a separate personality. The legal existence of a company (corporation) means it can be responsible for its own debts. The shareholders will lose their initial investment in the company but they will not be responsible for the debts of the company. Just as humans can have restrictions imposed on their legal personality (as in the case of children) a company can have legal personality without limited liability if that is how it is conferred by the statute.