DOCTRINE OF SEPARATE LEGAL ENTITY AND IT’S EXCEPTION
Authored by: Shubhang Swaroop
The Doctrine of Separate Legal Entity is a concept which makes a company a “Legal person”. It makes the company a different Legal person from its owner. It states that the owner and the company are two different Legal entities and they can be made liable Separately for the offence. The Doctrine tells that the company and the person owning the company, the company has its own obligations, its own Legal rights, its own existence which are different from the person opening the company.[i]
For the company to be called as a Separate Legal Entity there has to be proper incorporation and registration of the company. If the company has been properly incorporated, then only it will have a Separate Legal existence from its-
- Directors- As they regulate the working of the company.
- Members of the company– They are the real owners of the company
- Shareholders- They have subscribed to the shares of the company.
In HL Bolton Engineering Co Ltd v TJ Graham Sons Ltd[ii], it was decided by the court that in certain ways, a corporation can be compared to a living being. As the living person has its own brain and neurological system that regulates the working of the body similarly the company also have a set of brain and nervous system. It even has hands for its operation and working in line with the instructions by the directors of the company. Most of the employees in the organization are staff members and representatives who are the hands of the company, who do the job and who cannot be shown as a representative of the mind or will of the company. Others are executives and supervisors who represent the company‘s basic organizing thoughts, and regulate the working of company. The thought of these executives are the thoughts of the corporation and is handled as such by law.
- The company could have made any person liable who owns the company or works in the company, on behalf of the offence committed by anyone.
- They could have made agreements in such a way that both the person and company can be made liable.
- There would be many agreements which would be made wrongfully if a company is a part of group of companies.
- There would be court cases which are not wanted by the company as well the individual. The hearings in the court may be taken on the basis of, breach of fiduciary duty, criminal misappropriation, demand for punitive damages or any other cause of action regarding the person or the company, other than the Legal party. If it is successful, the claim may lead to personal liability.
Hence, it is necessary that there should be a concept of Separate Legal Entity present in the current scenario of the company otherwise there would be many misappropriations and which may further lead into the court cases.
There has to be a concept of Separate Legal Entity present in the current situation as the company is different from its owner. The most important reason is that the liability of any offence remains with the company and not to its owner, shareholders or director. The company should be itself liable for the offence committed by it.
Because a corporation is a free and Separate Legal body, the founders of the company are only liable to the degree of their involvement in the company. This means investors in the company are not fully responsible for any commercial loans and that lenders can not pursue their personal property for financial liability. Likewise, stockholders pay the taxes on any earnings compensated to them because of the profit made by the company. These earnings of the shareholders are in the form of salary, gratuity or reward, and the company on its own needs to pay company tax which is applicable on the earnings or on any additional profits at a lower corporate rate.
As the company is an independent organization from members, directors and shareholder, it does not disintegrate when one of the members or anyone resigns. If the any investor i.e. the shareholder passes away, the corporation may transmit its shareholdings in the same way as any other assets and the company is not adversely impacted.
The Doctrine of Separate Legal Entity was first applied in the case of Salomon v Salomon & co. Ltd.[v] In this case; Mr. Salomon registered a company under the Companies Act, 1862. He along with his family members became the shareholders of the company. The company had 20007 shares which could be subscribed by the people. Salomon subscribed to the 20001 shares and his family subscribed to the left over share which were 7. The value of each share was ￡1. He became the managing director of the company. The company after sometime went into liquidation i.e. financial difficulty. There was a rule that when a company goes into liquidation the first people who will be paid would be the secured creditors and then the left over money would be given to unsecured ones.
The assets which had to be distributed were of ￡ 6000. Salomon being the secured creditor of the company was to be given ￡10000 but there were only ￡6000. The remaining shareholders would receive no money because they were unsecured creditors.
The unsecured creditors claimed in the court that Mr. Salomon should not be paid first as he and the company is the same. The company does not have any different Legal existence from Mr. Salomon. He being the director of the company cannot claim the asset.
The House of Lords had a different opinion to it. They followed the rules which said that the creditor should be paid first. The court in their judgment said that the company is distinct and completely different from that of the person who runs it. The company has its own existence. The judgment favored Mr. Salomon and applied the Doctrine of Separate Legal Entity that Mr. Salomon and the company Salomon and Co. Ltd. are two entirely different personalities.
This Doctrine was also applied in the case of Lee v. Lee Air Farming Ltd.[vi] In this case; Mr. Lee who was a professional pilot had formed a company which had issued 3000 shares. 2999 shares were held by Mr. Lee and he became the director of the company. After sometime, Mr. Lee died in an accident and his wife claimed compensation from the company as well an employee of the company as well. She asked for compensation on the basis of the Employee Compensation Act but the company denied the compensation as he was the majority shareholder and the director of the company. He could not be allowed compensation as it was not covered under the definition of employee.
Therefore, in both cases it can be seen that a listed company is an independent company and it has its individual liability from its members, directors or shareholders. Even if a person who holds all the shares in a company and is an employee of the company, then also the company has its own identity.
It is an exception to the Doctrine of Separate Legal Entity as the Doctrine can be misused and the company members cannot be trusted blindly as they can commit fraud and still can gain money. In order to prevent the members from committing any offence or to prevent them from doing illegal acts in the name of the company. If the concept does not exist then the members of the company will try to misuse the Doctrine and the court will have to give the benefit to members who use the Doctrine of Separate Legal Entity as a defence.
Therefore, the concept of the lifting of corporate veil is also as necessary the concept of Separate Legal Entity. There are circumstances where the concept of a distinct body can be regarded as arbitrary and the courts can, on various grounds, take judgments opposing the concept of Separate Legal Entity. The court also takes judgments opposed to the concept of Separate Legal Entity in order to meet the individual behind the veil and to expose the true essence of the business. In order to find out, whether to ignore the Separate Legal Entity Doctrine or not, writers have often categorized the cases into many types of distinct classes, and no universal agreement as to the number or type of classes is formed till now but there are some cases which can be distinguished as Separate classes.
Penetrating through the veil is company law’s most generally used principle in which the court gives their decision to make or not to make the person liable who has committed an offence in the name of the company. This principle goes on and on and it is one of the most used principles in today’s world.
Penetrating through the veil law is present in the current as a sign of danger that the investors in a company which are the shareholders ought not to be held obligated for the obligations of their organization past the estimation of their speculation. The justification for giving individual financial specialists constrained obligation accentuates taking out three sorts of exchange costs. Firstly are the expenses of individual investors or loan bosses observing the riches position of different investors, and, secondly, the expenses and different complications of every investor or leaser checking the dangers of the executives actions. Third, restricted investor risk makes it less exorbitant and simpler for investors to enhance their speculations. The aftereffect of constraining these exchanges costs is that restricted obligation both energizes venture and encourages the activity of markets.
Hence, when the veil is lifted when the court leaves the company and makes the member liable for the act committed in the name of the company. “It is impossible to ascertain the factors which operate to break down the corporate insulation.”[viii] The case mostly depends upon the discretion of the court as well as it depends upon “the underlying social, economic and moral factors as they operate in and through the corporation.”[ix]
STATUTORY AND JUDICIAL EXCEPTIONS
The corporate veil is lifted under two different categories which are described as follows-
- Statutory Provision– There is certain sections which make members personally liable i.e. the corporate veil is lifted after the applicability of the Section.
- Non-compliance with requirement of incorporation (Sec. 7) i.e. there is no company in existence
- Mis-description of company’s name (Sec. 12 (3)) – When the name of company is decided it should be present on all the papers of the company and there should be any mis-description about it otherwise the person will be liable who has made the mis-description of company’s name on the paper. In the case of Hendon v Adelman[x], the director of the company signed a cheque in the name of L R Agencies Ltd. while the company’s name was L & R Agencies Ltd. In this case, the director was held liable as he had made the mistake of mis-description.
- Mis-statement in the prospectus- The prospectus should contain al; the details of the company rightly as if the details are not correct it can lead to commitment of fraud by the company.
- Facilitating the task of an inspector appointed u/s 210, 212 & 213- When an offence is committed and an inspector is appointed then the corporate veil is lifted so that he can look into the matter and he would need an in-out access of the information of the company.
- Fraudulent Conduct (Sec. 339)- In the case where the company is winding up but still is does business with an intention of doing fraud.
- Liability of Ultra Vires Act- If anything the company’ss member conduct is beyond the structure, power or Memorandum of Articles, and then the corporate veil will be lifted.
In the case of Weeks v property,[xi] the director of the company had surpassed his borrowing limit which was laid down in the MoA, but still the directors took the loan. The loan was held to be ultra vires and the corporate veil was lifted making the director of the company liable for the mis-conduct.
- Judicial Interpretation- There are certain rules which when broken may make the directors liable.
- For the protection of revenue- When a person uses the Doctrine of Separate Legal Entity in order to evade the tax liability on him, In the case of Sir Dinshaw Maneckji Petit v Income Tax Commissioner[xii] , the corporate veil was lifted in order to make Sir Dinshaw liable. Sir Dinshaw had been earning a lot of money by means of dividends and interest. Thus in order to evade tax liability, he formed four companies and in return purchased all the shares of the company. Thus court found that he formed the companies in order to evade tax liability and had no business of their own. Hence, he was liable to pay all the taxes which he had incurred.
- Prevention of Fraud and Improper Conduct- In order to protect the company from the fraud committed by its members, directors or shareholders, the corporate veil needs to be lifted.
In the case of Jones v Lipman[xiii], Jones wanted to buy the piece of land owned by Lipman, the sale was in process but Lipman did not want to sell the land. Hence, he formed a company and sold the property to the company and bought the share of the company. When James asked Lipman as the sale was in process, Lipman said that he wasn’t the owner of the land but it belonged to the company. Hence, the court in this case lifted the corporate veil and said that Lipman was the owner of the company and he had committed fraud. Hence, he should be liable for committing fraud.
- Determination of Enemy Character-A corporation may presume different character if the person who has the authority in the company is a resident from an enemy state. In such matter, the judiciary may investigate the character of individual who has the authority in the corporation and after investigation it will specify that whether the company is a enemy company or not.
In Daimler Co.Ltd V.Continental Tire & Rubber Co. Ltd[xiv], a corporation was fused in England in order to sell tires made in Germany by a German company which held the majority of shares in the English company. While the First World War was going on, the company started to recover the tax in the form of an exchange. The court in the case said that the company was a German company and said that if the money is paid to them the amount will be used by the German against United Kingdom so in order to protect the sovereignty; the company was not permitted to continue with the activity.
- The company is pretence – The courts will have to lift the veil where a company is a counterfeit.[xv]
The case of Salomon established the Doctrine of Separate Legal Entity in the corporate world. This Doctrine has been protecting the members, directors, and shareholders of the company. There have been many cases in which the Doctrine has been used as the court just needs to apply this Doctrine in the cases and give their judgment.
The applicability of this Doctrine depends upon the advocates and lawyers who present the case otherwise the court lifts the corporate veil and makes the members liable for their act. This is due to the situations and circumstances of the case and the perspective of the judge matters the most in it.
The Doctrine of Separate Legal Entity is a decent idea since it isn’t all the investors who do the business but there are also many people in the company who do the business. This Doctrine is a necessity as if a company commits any offence then the whole of the directors, members and shareholders cannot be held liable.
It is presumed that a company is a different legitimate individual, Separate from its individuals and a firm after its appropriate fuse through corporate law secures a juridical status. A company can maintain its business through its delegate and specialists and all the exchange made by any individual from the company will be viewed as the exchange of the company, whenever done by the individual who is approved to do it. The company can sell a property possessed by such enterprise and furthermore can purchase any sort of property. So the organization has the Legally binding limit and it can go into the agreement with any individual even with its own workers and investors. So the company can sue and can be sued.
This disclaimer informs readers that the views, thoughts, and opinions expressed in the text belong solely to the author, and not necessarily to the author’s employer, organization, committee or other group or individual.
[i] Leigh Ellis, Separate Legal Entities (Advantages & Benefits) in Business, HALLE ELLIS SOLICITORS, ( May 24, 2020), https://hallellis.co.uk/separate-legal-entities-meaning/
[ii] 1957 1 QB 159
[iii] Bhanu Srivastava, The Corporate of Separate Legal Entity in light of Corporations, ACADEMIKE, (January 30, 2015), https://www.lawctopus.com/academike/concept-separate-legal-entity-light-corporations/#:~:text=Forming%20a%20corporation%20offers%20legal,from%20the%20incorporated%20company%2C%20Inc.&text=This%20distinction%20protects%20business%20owners,and%20secures%20their%20personal%20assets.
[iv] Rodrigo, The Doctrine of Separate Legal Entity: A Case of Salomon v Salomon & Co. Ltd., THE WRITE PASS JOURNAL,( November 8, 2016), https://writepass.com/journal/2016/11/the-doctrine-of-separate-legal-entity-a-case-of-salomon-vs-salomon-co-ltd/
[v] 1897 AC 22
[vi] (1961) A.C. 12
[vii] Ruchika Jha, Lifting of Corporate Veil,of a Company under Company Law, LAW TIMES JOURNAL, (March 3, 2020), http://lawtimesjournal.in/lifting-of-corporate-veil-of-company-under-company-law/
[viii] Warner Fuller, The Incorporated Individual: A Study of One-man Company,(1938) 51 Harv LR
[ix] Tata Engineering Locomotive Co v. State of Bihar AIR 1965 SC 40
[x] (1973) Ne-Delhi LR 637)
[xi] (1873) L.R. 427
[xii] AIR 1927 Bom. 79.
[xiii]  1 WLR 832
[xiv]  2 AC 307
[xv] [xv] Law Student, Lifting of Corporate Veil, LAW TEACHER, (February 2, 2018), https://www.lawteacher.net/free-law-essays/business-law/article-on-lifting-of-the-law-essays.php#:~:text=Judicial%20Provisions%20Or%20Grounds%20For,as%20an%20engine%20of%20fraud.