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Example Law Essay

Critically assess the effects of corporate separate personality.

The fundamental concept of corporate separate personality recognises that a company, once incorporated, becomes a ‘body corporate’, i.e. a legal entity distinct from its members and officers. The various effects of corporate separate personality shall be dealt with in turn.

1) Distinct legal identity from its members

One of the most significant effects of corporate separate personality is that the company assumes a separate identity from that of its members. Even if a company is owned outright by one shareholder, the company has a completely separate personality from that individual. This is confirmed by the leading case of Salomon v A. Salomon & Co Ltd in which the House of Lords held that the company’s acts were its own acts, not those of Mr Salomon personally. As a result, Mr Salomon was not personally liable for his company’s debts. It is worth noting, however, that the Court did recognise that there would be situations in which they would be prepared to move away from that principle and ‘lift the veil of incorporation’ and find individuals liable where they had acted dishonestly, fraudulently or unreasonably.

2) Limited liability

Due to the fact that the company is a separate legal individual, it follows that its members will not generally be liable for its debts and obligations. This gives the shareholders a great level of security, since it means that they are able to profit from the successes of the company whilst being safe in the knowledge that their personal liability is limited to the value of the shares they have purchased. However it should be noted that those members who participate in the management of the company will not necessarily be protected from personal liability. In addition, the concept of limited liability may not be attractive to potential creditors who may require additional security for their loan.

3) Ownership of Property

Where a company holds property in its own name, this belongs solely the company and the shareholders have no proprietary rights (other than for the value of the shares they hold). This gives shareholders and employees more security than if a director chose to leave his position and was able to enforce a sale and division of any company property or assets he owned. This position therefore makes the shareholders’ investments more attractive and secure. However, this may be to the detriment of a trader who owned the company property before incorporation but failed to subsequently assign the insurance policies to the company. This was illustrated in Macaura v Northern Assurance Co wherein Mr Macaura had insured timber under his own name and this was then destroyed by a fire. The insurance company refused to pay out on Mr Macaura’s claim, stating that he had no insurable interest in the timber as it was owned by the company. In the same way, a parent company does not have an insurable interest in its subsidiary companies, even where they are wholly owned by it.

3) Transferable shares and transparency

The fact that a company is legally separate from its members facilitates the transfer of shares. The issue of shares is regarded as a fundamental means of raising capital for the company (although smaller traders are often attracted by the concept of incorporation merely as a means to protect themselves from potential unlimited liability). The exchange of shares on the open market also leads to transparency since it acts as an incentive for management to conduct the business in a reasonable manner. This transparency enables greater scrutiny by outsiders of the company’s affairs and reduces the opportunity for fraudulent behaviour, thereby improving the marketability of the shares. It also means that investors are able to obtain the requisite information they need in order to evaluate the company before entering into business transactions. From the company’s point of view, however, this transparency can often lead to disclosure of information that they would have preferred to withhold and put them in a more vulnerable position with competitors.

4) Ability to sue and liability to be sued

The main benefit to traders of incorporation is the concept of limited liability; however, this can act to the detriment of third party creditors who enter into transactions with the company. Whilst the creditors will be able to sue the company itself, they may not be able to recover their money if the company is insolvent. It should be noted also that a company is able to sue its debtors for non-payment. So it is a legal individual that can both sue and be sued.

5) Perpetual succession

After being legally created by incorporation, a company can only subsequently be terminated by the law. Unlike people, companies are immortal and will continue to exist after the exit or death of its members by the process of perpetual succession. Obviously a reduction in the number of members (particularly if they owned a substantial shareholding) may affect the company in terms of morale, profit levels, functioning, etc, but the actual company itself will remain in existence. The only manner in which a member is able to realise the value of his shares upon leaving the company is by selling them to another individual – there is no entitlement to be bought out by the firm. Regardless of whether an individual’s shares are sold (or, if he died, then left to another in his will), this will not affect the company itself. Shareholders of the company are merely agents of the company; they can come and go without affecting the company’s existence. Therefore, it is easier and potentially less damaging to remove a fraudulent or disreputable director from a company than a partnership (where that individual would be able to jeopardise the business by taking with him any assets or capital that he owned). There is also greater security for employees since they will not be at risk of losing their jobs due to the death of their employer, as the company will continue to exist.

The benefits of incorporation to a sole trader or small partnership are obvious. The company will have greater access to capital, thereby increasing the business’s chances of prosperity.

In conclusion, the effects of corporate separate personality are far-reaching. A company is regarded as a legal entity in its own right and, as such, its members have limited liability for its debts and obligations. The company is able to own property in its own name and issue shares to raise capital. It is able to sue debtors and similarly be sued by its creditors. Finally, a fundamental characteristic of corporate separate personality is that of perpetual succession, which results in a continuation of the company’s existence regardless of its members.

BIBLIOGRAPHY

Birds, J. & Boyle, A. – “Boyle and Bird’s Company Law”; Jordans Ltd; 6th Revised Edition; (2007) Davies, P. L. – “Principles of Modern Company Law”; Sweet and Maxwell; 7th Edition; (2003) Digman, A. & Lowry, J. – “Company Law”; Oxford University Press; 4th Edition; (2006) Keenan, D & Bisacre, J.- “Smith & Keenan’s Company Law”; Longman; 13th Edition; (2005)