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INTRODUCTION
A corporate body, once registered under Companies Act, 2013, it is clothed with legal fiction of being referred as “Company”. It is considered as an Artificial Judicial Person i.e., created by law with independent existence from its promoters, directors, employees and members. It is a fundamental principle of Company Law as it demarcates between the roles & duties of people involved in the ownership, management & employment of the Company.
Separate legal entity acts as a veil between company and its member. It means that assets of the company shall be used only for the objective of the company as set in Memorandum of association and its liabilities should be paid by itself and not from personal asset of the member of the company.
EMERGENCE OF THE PRINCIPAL OF SEPARATE LEGAL EXISTENCE
A company is vested with a corporate personality so it bears its own name, acts under name, has a seal of its own and its assets are separate and distinct from those of its shareholders. It is a different ‘person’ from the members who compose or manage it. Therefore, it is capable of owning property, incurring debts, borrowing money, having a bank account, employing people, entering into contracts and suing or being sued in the same manner as an individual i.e., in its own name. Its members are its owners however they can be also be its creditors at the same time. Even if a shareholder virtually holds the majority number of shares, he cannot be held liable for the acts of Company unless after lifting of veil, it is proved that indeed the shareholder was acting through the Company.
The principle was first recognised in 1867inOaks v. Turquand & Harding[1], it was held that since law grants a fiction to Corporate entity, it is distinct from its members & creditors of the company can claim only against the company & not the individual shareholders.
Before the Salomon’s landmark judgment where the principle of “Separate legal entity” was judicially recognised, it also emerged in Re. Kondoli Tea Co. Ltd Case[2], wherea Company’s shareholders’ transferred their properties in the name of Kandoli Tea estate to claim exemption from ad-valorem tax. It was held by the Court that it is a valid conveyance or transfer as Shareholders & Company are separate from each other. After this case there were several landmark cases which reiterated this position & delved in much deeper rationale of the principle.
- Salomon v. Salomon and Co. Ltd.[3]
Facts: Mr. Aaron Solomon was a successful trader in leather & Boot. He set up a Limited Company with 20007 shares, out of which 20001 shares were subscribed by him & the remaining 6 shares were subscribed by his family members (wife & five children) one each. Salomon & his 2 sons were Managing director & Directors respectively. The actual cash paid as capital was £ 7. Solomon sold his business to the Company for £38,782. The company’s nominal capital was £40,000 (40000 * £1 shares). In part payment of the purchase money for the business sold to the company, debentures worth £10,000 secured by a floating charge on the company’s assets were issued to Salomon, who also applied for and received an allotment of 20,000 at £1 fully paid shares. The remaining amount of £8,782 was paid in cash to Salomon.
The Company soon started incurring losses & had to undergo liquidation. Receiver was appointed who valued the assets at £6050, secured liabilities at £10000 (debentures owned by Salomon) & unsecured liabilities at 8000.
The Unsecured creditors argued that the Company is merely an agent or alias of Mr. Salomon, hence, the assets should be used to satisfy their debts & not that of Salomon himself. Further, they pleaded that Salomon is the principal beneficiary, thus, he was ultimately responsible for debts incurred by his agent.
Judgment: The lordships observed that the Company does not work in the capacity of Agent or alias of its subscribers or directors. It is altogether a separate legal entity from its subscribers. Hence, the Company does not lose its independent identity even if its capital is held by single person or members of same family. Even though, the profit was received by the same hands which incorporated it, does not Company his agent or trustee. This decision highlighted “the principle of separate legal personality” as a “double edged sword”.
- Lee v. Lee’s Air Farming Ltd.[4]
Facts: Mr. Lee formed a Company named “Lee Air Farming Ltd.” In 1954 for the purpose of Aerial Top-dressing business. Lee held 2999 shares of £1 dollar each out of 3000 shares & was also the director of the said company. The Company had various insurance contracts for its employees & premiums towards Lee’s insurance was debited from Company’s Accounts. Lee was also Pilot in the Company. Lee died in accident while piloting in 1956. Lee’s wife claimed compensation from Company as he died while working as an employee of the Company. The Company argued that a person cannot employ himself as worker while being the owner of the Company.
Judgment: The Court reiterated the principle & stated that although Lee was the owner & majority shareholder of the Company, but at the time of his death he working in the capacity of Company’s employee & not it’s owner, both the positions are separate from the actual identity of Company. Hence, Mrs. Lee was held entitled to compensation from the Company.
ADVANTAGES OF A SEPARATE LEGAL ENTITY
- Limited liability of members: The Company being separate person, is the owner of its own assets & liabilities. The Owners of the Company are neither the owners of its assets nor bound by the debts of the Company. The member is only liable to pay towards his share in the capital i.e., he is only liable to pay the balance remaining unpaid towards his shares. Similarly, in case of a company limited by guarantee, the member is liable to pay the amount guaranteed amount specified in the Memorandum of the Company. There are certain exceptions to this i.e., in case of Unlimited Company, company incorporated by furnishing false or incorrect information, business is carries to defraud creditors, prospectus is issued to defraud applicants or any other case as specified by the Statute.
- Perpetual succession & winding up: A company has artificial existence (because of legal fiction granted) & it exists independent of natural persons associated with it. Hence, it never dies except in the case of winding up. The membership of company can change from time to time but the company continues in perpetuity. A company’s existence is terminated only by winding up i.e., it has to go through legal procedure to stop its functioning unlike a natural person.
- Separate property: Company is capable of owning, enjoying & disposing off its assets. It can incur liabilities in its own name.Although Company’s assets & capital are contributed by its shareholders, but they cannot exercise any right over it unless authorised by company.
- Capacity to sue & be sued: Company can institute legal or arbitration proceedings against anyone including its own members in its own name. Any legal action can be instituted against the Company. It has right to seek damages for loss of reputation caused by publishing defamatory statements.[5] It can also sue as a pauper[6] & is not liable for the contempt committed by its officer.[7] Similarly, company can take legal action to enforce its rights in torts & can be sued for breach of its legal duties.
- Contractual rights: Company can enter into contract in its own name. Shareholders are not entitled personally to participate or derive any benefits arising from any contract entered by company unless otherwise provided.
PRINCIPLE OF “CORPORATE VEIL”
In the case of Salomon, it was observed that although the principle of “separate legal entity” is an important feature of a Company, but it is a “two-edged sword” because, it acts through its members & management, so, sometimes, the members while hiding behind the veil can use the name of Company for their personal gain leaving the position of company in jeopardy. Corporate veil is a doctrine which separates the actions of Company from that of shareholder. Courts have to “pierce the veil” to identify whether shareholders or management is responsible for a Company’s actions or not. The real intentions of persons acting through the Company can only be traced after removing the veil (facade), thus, the courts will look behind the veil & take action as though no entity separate from members existed & make the members liable for debts & obligations of the company. However, shareholders themselves cannot request court to lift the veil for their own purposes.[8]
CONCLUSION
The purpose of recognizing Corporate as a “separate entity” from its members & management, is to insulate the members from incurring personal liabilities which may arise as a result doing business. On the other hand, it ensures that Company is not held liable for the actions of its shareholder in his personal capacity. This independence ensures that the interests & liabilities of both, owners & Company are protected.
References:
[1] L. R 2 H. L. 325 (1867).
[2] ILR 13 Cal. 43 (1886)
[3] A.C. 22 (1897).
[4] A.C. 12 (P.C.), 1961
[5] TVS Employees Federation v. TVS and Sons Ltd., 87 Com Cases 37 (1996).
[6] Union Bank of India v. Khader International Construction and Other, 42 CLA 296 SC (2001).
[7] Lalit Surajmal Kanodia v. Office Tiger Database Systems India (P) Ltd., 129 Com Cases 192 Mad (2006).
[8] Premlata Bhatia v. Union of India, 58 CL 217 (Delhi) (2004).
