I- Broad Definition and History of the Legal Entity

The concept of a separate legal entity has existed for more than 500 years. The development of the company’s personality was created by the case of Salomon v A Salomon and Co Ltd.[1]which is playing an important role. Later on, companies can now own and sell a property just like a real person. Also as a legal person; they can sue parties and also can bring a case.

The history of corporation is based on very old times. When looked back, it is seen that the companies were not for commercial purposes but were established for religious and church institutions in Europe in middle ages. These institutions received their powers by the local lords and by the statutes given by the kings. These organizations called charters and they were created with the aim of holding properties. These institutions, which had the privilege of the royalty, were not subject to heavy taxation. After the 16th century, the scope of the charters property acquisition expanded and became part of including hospitals, universities and colleges. But until then, these organizations were not used for commercial purposes.[2] Individuals such as kings and bishops were included in these companies. These were known as sole corporations. The purpose of this corporation was to publicly disclose that these properties were not owned by the individual and that the contracts were not made on behalf of the individual.[3] All these companies were known as aggregate corporations and for the first time in the 17th century, charters were used for commercial purposes.[4]

With the passing of time, the charters expanded with the local authorities and became the commercial organization called guilds of merchants. The changing balance of power between the throne and the parliament was also reflected in the structure of the charters. In this way, the charter’s privilege was subject to the approval of the parliament. At the beginning of the 18th century, these companies had an active market for the trading of shares. However, in the so-called South Sea Bubble, state’s incompetent sanctions and insecurity caused markets to collapse and many charter crashed as a result. These charters, which could not be fully regulated and framed, were put under pressure by the state and certain rules that are still in use today are passed through parliament. The Joint Stock Companies Act 1844 created this arrangement and defined the definition of incorporation. However, the company still held its members accountable for its debt. Thus, it was revealed that the principle of limited liability with separate legal entity will not be the same and should not be confused. With the Limited Liability Act 1855, the principle of limited liability has become an indispensable element of companies. Thus, in the last 160 years, the concept of company has increased its economic importance and created the concept of corporate law by creating its own legal field.[5]

II- Case of Salomon v A Salomon and Co Ltd.

Wide Details of the Case

One of the most important cases related to the history of incorporation is the case of Salomon v A Salomon and Co Ltd.[1], which is even the cornerstone of the company law. With this case, legal personality protection, which is still valid today and limited liability principle for shareholders and partners, has come to the agenda.[2] In the 19th century, Mr. Salomon was a successful leather merchant and he was a sole trader. There were not many people who could compete with Mr. Salomon. Mr. Salomon then established a limited liability company with 20007 shares and bought 20001 and shared the remaining 6 equally with family members. After establishing his company, he sold his previous leather business to his own company. After the payment made with the shares and the cash; there were still 10,000 pounds to be paid as a credit to Mr. Salomon. This was secured in the form of debenture. Mr. Salomon finished all procedures required for a company’s establishment and followed the regulations. The company had a total of 7 members with its family, but due to its shareholding, he was the company’s major shareholder and was therefore the main creditor of the company. After a certain period of time, Mr. Salomon’s newly established company didn’t work well and it was up to the company to go to liquidation. The real problem here was that the court would give a priority to Mr. Salomon who is a secured creditor or whether give it to another unsecured creditor. If the court gave priority to Salomon’s claim, nothing would be left for the other creditors. Because the company’s shares were very low and did not meet the required debt. The liquidator who appointed for the liquidation of the company said that Mr. Salomon took over the business of leather trade deliberately. He also considered that the company had acted as a representative of Salomon’s agency and that the debts had to be paid by Salomon to the unsecured creditors. After considering the liquidator’s argument and the process, the court justified the liquidator and told him that Mr. Salomon was responsible. After that Mr. Salomon appealed and when it was in the Court of Appeal Salomon’s objections were rejected again and the first-degree court was justified. It was decided that Salomon had abused the company and its limited liability principle. It was presumed that the principle of limited liability was valid only for fair and devoted shareholders, and it was argued that Salomon steered his company as it was in the leather trade business where he was the sole trader. However, House of Lords which is the last authority, rejected this matter and this concept was established as the basis of corporate law. It was unanimously accepted by House of Lords that company is a separate legal entity from its members and shareholders. It was repeated that all procedures for the formation of the company were completed. It was found by the House of Lords that the Salomon’s company was established in a legally valid manner and that the company’s debts were their own debts and members were not responsible for the payment of the company’s debts. For these reasons, as a legal entity, the company has been legally established pursuant to all the rules related to company laws. The management of the company by one person or all shareholders was decided not to make any difference. Therefore, the priority and preference were given to Mr. Salomon.[1]

Progress Brought by the Case

The foundation of company law is based on the concept that a company is a separate legal entity.[1] As a result, the company has a separate legal entity from its members and shareholders.[2] The company refers to a juristic person. In the words of Lord Baron Thurlow company means; “…have a conscience, when it has no soul to damn and no body to kick…”[3] When a company is established, company as a legal result of the concept that mentioned; is treated as a separate legal entity from its managers, shareholders and employees.[4] Thus, it is seen that a there is a metaphoric veil between the company and with its founders and shareholders.

The decision in Salomon v A Salomon and Co Ltd.[5], is vital because it will not hold individuals under threat of responsibility if the company goes bankrupt and encourages businesses to provide money. The main purpose behind the Salomon principle was to encourage investors to provide money to a business without further risk; however, the Salomon principles have been criticized for failing to provide creditors with adequate protection. It can be said that limited liability principle does not play an important role in small private companies with small capital. When companies want to borrow beyond their capacity, the protection of limited liability is lost. Banks and other creditors generally require managers or shareholders to provide personal collateral to be personally responsible for the company’s debts if it fails. In this sense, the advantages of limited liability are limited.[6] Undoubtedly, the principle that came up with the Salomon v A Salomon and Co Ltd.[7], ensured the company’s separate legal personality, which allowed shareholders to personally leave this situation without minimum risk even if the company collapsed or went into liquidation. However, there are still cases where the court disregards this principle and takes exceptional decisions. Also, it remains a daunting task for academics and practitioners to find a basis on which to justify the veil-piercing. Because in such a case the personal opinions of the judges come to the fore and there is a moment when the facts of the case are important. Nevertheless, the Salomon principle is widely recognized by the courts and is maintained as far as possible. The principle of separate legal personality as set out in Article 16 of the Companies Act of 1997 constitutes the basis of company transactions in the courts. Case of Salomon v A Salomon and Co Ltd.[1] has become a case-law in corporate law as a turning point in the UK, and still holds the most important principle that forms the basis of companies today.

III- The Company as a Separate Legal Entity

Matters Related to the Legal Personality of the Company

The fact that the company is a legal entity means that it is a legal person with certain rights and duties in the eyes of the law. Each state has its own corporate law, legislations and doctrines. However, in company law, certain principles such as acquiring and selling property by the company are universal. Company can be prosecuted and sued also company can prosecute or sue someone by itself. Although the law gives rights to the legal entity as a natural person, it imposes some restrictions on it. The company is a legal person but cannot hold any public office, vote in general elections, participate in elections and cannot interfere in state affairs.[1] If the word “person” in a statute or law is not suitable to be interpreted differently according to the letter of the law, it is usually referred to as a juridical person or natural person. With this fact company is a juridical legal person and should be defined as separate legal person. It is seen that the personality of the company is separated from its partners and shareholders.

There are four basic elements that make up the legal entity of the company:

Ensuring Continuity: This means that a company carries out its business, continues to hold its properties, and carries out its actions in contractual relations without any gaps. In other words, the existence of a legal entity will not end with the death of the owner or withdrawal of the assets. The life of the legal entity is immortal. That is, it can continue its activities without leaving any space until it enters into any procedure.[2] Providing “Identifiable Persona”: This definition means that the company’s recognition is prominent. The name of the company continues its business activities as a legally liable person. Persons who are in this company and those under the roof of this institution are referred with that company’s name. This intangible concept is a wide range of the company’s monopoly rights, reputation, dignity, and other rights. These intangible assets exist as companies’ source of value.[3] When the suit is filed or when the company wants to file a case; transactions are carried out also under this company’s name. It is usually the company itself, rather than the members or partners of the company being sued.[1] Therefore, companies usually have their own legal advisory teams in connection with these litigation works.[2]

 The Principle of Separation of Company Assets: The fact that the company’s assets are separate from shareholders is a statement that the company has a personality itself. It should also be determined what businesses are allocated for these assets. With this distinction, it becomes easier to invest in for the ones who wants to invest and in particular, it becomes easier to determine who owes the debt to whom at the time of liquidation.[1] In other words, the concept of limited liability is the basic element of this separation. The limited liability that comes with this separation means that the liability of the shareholders for the company’s liabilities is limited to the investments made by the shareholders to the company.[2] This limited liability only applies to shareholders, stockholders and people who are managing under the company.[3] The Company is exempt from this limited liability principle.[4] The legal justification of the concept of limited liability is to encourage investment by briefly mitigating the risks that may be incurred on behalf of the company.[5] Therefore, limited liability concept provides investors with the opportunity to continue their investments comfortably by knowing that the creditors will not recourse to them even under the assumption that company is in debt. Thus, the risk that the investor carries under the name of the company is limited with their investment in the company.[6]

Self-Management: The company, which has acquired a legal entity with a separate title, is also a mechanism governing its internal affairs. Company derives this authority from its bylaws. 

In addition to these matters and advantages, the concept of incorporation that comes with the principle of separate legal personality has also disadvantages. This legal entity protection is open to abuse; in some cases, it is used by people with bad faith to cover the lawlessness. Avoidance of Legal Obligations: The concept of limited responsibility forces small business owners to institutionalize. It provides them with an environment in which they can escape the persecution of unlimited responsibility.[7] Creditors are limited to the capital of the company in order to collect their receivables. Thus, the limited liability principle discourages shareholders from monitoring and controlling the commercial ventures of their companies. The creditors of the company bear the burden of the risks that may arise in their relations with limited companies.

A Tool for Fraud:  With the case of Salomon v A Salomon and Co Ltd.[1], the legal doctrine considers each company as a separate legal entity. With this principle, a suitable environment for fraud can be provided. In order to protect against the claims of creditors or members, this feature has led to fraud and anti-social activity that develops many times in different ways.[2]

Restrictions on Shareholders: There are a number of procedural difficulties for shareholders to sue on behalf of and on behalf of the company. The case of Foss v Harbottle[3] is an example of this. In this case, two shareholders sued other company’s shareholders, lawyers and architects on their behalf. They alleged that the defendants had abused the property of the company fraudulently and also board had not assemble properly. The Court held that the complaint complained by the plaintiff had been harmed on behalf of the company and not on them. It was therefore decided that the company should sue on its behalf by providing the required majority of shareholders and not the company.

Limited Role of Shareholders in Management: There is a separation of power between the shareholders and managers of a company. If the case of Winthrop Investments Ltd. v Winns Ltd[4]. is cited; “… because they may not have the ultimate control, because they can’t change the articles, but they can’t interfere in the board. No general power to transact the company’s business, or to give effective directions about its management. ” the separation can be seen clearly. The fact that the shareholder owns shares in a company and cannot fully participate in the decisions regarding the management of the company constitutes a problem for the shareholders.

The balance of advantages and disadvantages with respect to companies varies in proportion to the size of the company. For large trade organizations, the elements that are in favor of the incorporation are more certain. In the case of large firms, shares between the board of directors and shareholders, transferable shares and limited liability to shareholders are not helpful in raising capital. Therefore, the main issue has been how easily small firms can reach on behalf of incorporation. This access, which has been coming since the Salomon principle, remains unrestricted and promoted. It is tried to facilitate the incorporation and limited responsibility of small-scale businesses.[5]

Cases Concerning the Separate Legal Entity Principle

The principle that a legal entity of a company is separate from its shareholders and its owners is based on old times. Based on this, there have been several cases which have reinforced this principle since the 17th century. In addition to the aforementioned case of Salomon v A Salomon and Co Ltd.[1], there are also other cases that reveal the importance of the legal entity of the company.

The Kondoli Tea Company Ld. v Unknown[2]

In the Kandoli Tea Company, there were number of people who wanted to transfer their property on behalf of the company and avoid paying taxes that arising from property. After the process progressed, they wrote petitions and took this issue to the court. Persons who wanted to be exempt from paying taxes by transferring their property to the company, said that they demanded to be exempted from paying any taxes on their behalf. When the proceedings were initiated and after examining the existing records the court decided that the company has its own legal entity and also these properties belong to the company’s name. For this reason, the tax exemption has been approved by court for petitioners and the court did not hold them responsible for this debt.

Macaura v Northern Assurance Company Ltd.[3]

Macaura was one of the main shareholders of a timber company. The majority of the company’s shares belonged to Macaura. At the same time, he was one of the priority creditors of the company. After that insured timbers burnt because of an accident and due to this incident he wanted to compensate the damages from the insurance company. But insurance company said that the goods belong to the company, not to him. Hence, insurance company claims that there would be no payment made to Macaura because he was not the owner of the timbers. After some process and when this issue showed up in the court; court applied the Salomon principle and expressed the importance of the legal entity. The court clearly stated in its decision that the timber which had been damaged was the property of the company rather than Macaura. Therefore, the court stated that if someone wants to insure the timbers; this right belongs to the company and Macaura does not have any right in this matter. In the end he did not compensate any payment in respect of this decision and the importance of the legal entity of the company.

Lee v Lee’s Air Farming Ltd.[1]

Mr. Lee was the executive director of the company. Taking advantage of this position, he appointed himself as the pilot of the company. He later died as a result of an accident on a flight while he was doing a job-related trip. Mr. Lee’s wife requested compensation from the company for his husband’s death. The other party claimed that Mr. Lee and the company are in fact the same person and therefore no compensation can be made. When this situation took place in the court, the court ruled that Mr. Lee was a separate person from the company’s legal entity and he had only established the company. Court therefore decided a compensation for Mr. Lee’s wife. At the same time, they reiterated that the company legal entity is a separate person. It is possible for the company to enter into a contractual relationship with other persons and being an executive director in a company does not make a problem for that very company to employ that person.

Last Words About the Existence of the Legal Entity

Company should be treated as a new person after the establishment of the company together with the principle of separate legal entity which is the main cornerstone of the corporate law. Another important issue brought about by this principle of separation is that individuals acting on behalf of the company considered that they act on behalf of the company, not on their behalf, at the time of the action.[2] If a person is held responsible for an act which that person made on behalf of the company, no one will want to be responsible because of the fear factor. Accordingly, this separate legal entity principle encouraging commercial enterprises while limits the liability risk for individuals.[3] As a result, in the above-mentioned cases and subjects, companies have separate legal entities and this separation separates the company from its members and shareholders. A company can conduct business by its agents or representatives. When the transactions are carried out, the person who is authorized to carry out these transactions shall be deemed to have a transaction on behalf of the company. The company which has the capacity to make a contract can contract with any person and buy and sell properties. In addition to the principle of separate legal entity, the company may also prosecute or be prosecuted if the contract is violated by the parties.

However, against the protection of shareholders, owners and those who have executive status under the umbrella of the company, the veil-piercing doctrine as an antithesis has also existed in the legal system to prevent any abuse. With this balance and control system, it is aimed to prevent malicious acts that can emerge because of the legal entity which provides protection to its’ company’s agents.

ATT. EREN GUNDAY, LL.M.

info@aet-partners.com

1 [1897] AC 22 

2 Ron Harris, Industrializing English Law, (Cambridge: University Press, 2000) 

3 Margaret M. Blair, The Four Functions of Corporate Personhood. (Vanderbilt University – Law School, Research Paper No. 12-15, 2012) 

4 Ibid 

5 Alan Dignam, John Lowry, Company Law, (9th Ed., Oxford University Press, 2016) p.15-16  

6 [1897] AC 22 

7 Loraine Talbot, Critical Company Law, (2nd Ed, Routledge, 2016) p. 44  

8 Nicholas Bourne, Bourne on Company Law, (7th Ed, Routledge, 2016) p. 18-19 

9 Andreas Cahn & David Donald, Comparative Company Law: Text and Cases on the Laws Governing Corporations in Germany, the UK and the USA (Cambridge University Press, 2010) p.625 

10 Brian Coyle, Risk Awareness and Corporate Governance, (Global Professional Publishing, 2 Ed, 2004) p. 178. 

11 John Coffee, No soul to damn: No body to kick: An unscandalized inquiry into the problem of corporate punishment‘(79:3 Michigan Law Review 386, 1981) 

12 S 19(1) (b) Companies Act 71 of 2008 

13 [1897] AC 22 

14 Fang Ma, Company Law, (2nd Ed., Pearson, 2016) p.24-26 

15 [1897] AC 22  

16 [1897] AC 22 

17 Schane SA (Corporation is a Person: The Language of a Legal Fiction. Tul.lL.Rev.1986) p. 563. 

18 Trustees of Dartmouth College v. Woodward (Superior Court of the State of New Hampshire February 2, 1819). 

19 Margaret M. Blair, The Four Functions of Corporate Personhood. (Vanderbilt University – Law School, Research Paper No. 12-15, 2012)  

20 Madhu Tyagi & Arun Kumar, Company Law (1st Ed, Atlantic, 2003) p.34 

21 Tarr GA, Judicial Process and Judicial Policymaking (6 Ed. 2013) p.103 

22 Margaret M. Blair, The Four Functions of Corporate Personhood. (Vanderbilt University – Law School, Research Paper No. 12-15, 2012) 

23 W.H. Cortenraad, The Corporate Paradox: Economic Realities of the Corporate Form of Organisation (Springer, 2000) p.88 

24 J.K. Vandervoort, Piercing the veil of limited liability companies: The need for a better standard‘ (3:1 Depaul Business & Commercial Law Journal,2014) p.54 

25 P.L. Davies, Introduction to Company Law (2 Ed. 2010) p.10 

26 N Allen, Reverse piercing of the corporate veil: A straightforward path to justice (16:1 New York Business Law Journal, 2012) p.25 

27 W. Forbes Behavioral Finance (2009) 288 and Watt KB Piercing the corporate veil: A need for clarification on Oklahoma‘s approach‘ (1993) p.28 Tulsa Law Review 869. 

28 Goulding, S, Principles of Company Law, (London: Cavendish Publishing Limited, 1996), p. 49  

29 [1897] AC 22 

30 Gonzalo Villalta Puig, A Two-Edged Sword: Salomon and the Separate Legal Entity Doctrine (Volume 7, Number 3 September 2000, Corporation Law – Australia) 

31 [1843] 67 ER 189 

32 [1975] 2 nswlr 666 at [683] 

33 Davies& Worthington, Principles of Modern Company Law, (9th Ed.i Sweet&Maxwell, 2012) p.53-54  

34 [1897] AC 22 

35 [1886] ILR 13 Cal 43 

36 [1925] AC 619  

37 [1960] UKPC 33 

38 Anderson H (2004) The theory of the corporation and its relevance to directors’ tortious liability to creditors. Australian Journal of Corporate Law 16(2): 73-95. 

39 GH Fridman, Personal Tort Liability of Company Director (5 Canterbury Law Review, 1992) p. 41-44  


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