This article is written by ALI LOVINA CHINONSO a final year law student at UNIVERSITY OF NIGERIA, ENUGU CAMPUS during her internship at LEDROIT INDIA.
KEYWORDS: incorporation, shareholder, Piercing the veil, Legal entity, Liability
Abstract
A fundamental tenet of corporation law is the idea of independent legal personality, which allows companies to function as separate legal entities from their members. This principles of separate legal personality also known as juridical personality or corporate personhood allows the company to have its own legal standing and possessing some duties which is recognized by law.
This principle was first established by the English House of Lords in Salomon v. Salomon & Co. Ltd. and well accepted as part of Malaysian company law. In this case, Aron Salomon was a successful business man who is into leather and boot manufacturing and he was solely running the business. Later on, he decided to transfer the business into limited liability company
In furtherance, the subscribers of the memorandum include Salomon, his wife and five of his children. He has been involved in receiving of debentures and has continued to carry on the business as before. A year after, the company went bankrupt and was put into liquidation. There were just enough assets to pay off the debenture holders including Salomon himself. The unsecured creditors claimed that the company was “mere nominee and agent of Salomon”. The Lord Macnagthen held that “though it may be that after incorporation the business is precisely the same as it was before, and the same persons are managers, and the same hands receive the profits, the company is not in law the agent of the subscribers or trustee for them”
From the very moment of incorporation of a company, it assumes this separate legal personality status, entrusting it with sets of rights and obligation. Some of the rights of a company are the right to own assets, enter into contract, incur debts, and to sue and be sued in its own name.
The provision of Section 42 Of The Company Allied Matters Act 2020, established separate legal personality and it provides that as from the date of incorporation mentioned in the certificate of incorporation, the subscriber of the memorandum together with such other persons as may become members of the company, shall be a body corporate by the name contained in the memorandum, capable of exercising all the powers and performing all functions of an incorporated company including the power to hold land, and having perpetual succession, but with such liability on the part of the members to contribute to the assets of the company in the event of its being wound up as is mentioned in this Act.
In essence, a company is a separate legal entity from its members/shareholder and the company can own asset, enter contracts, and sue and be sued in its own name. In the case of Foss v Harbottle, the court upheld the principle of separate legal personality and held that if the company is involved in legal proceedings, it must be initiated in their name of the company, and not in the name of the shareholders or directors as it is the company that, which exits as its own legal person, itself being sued and suing.
DEFINITION OF SEPARATE LEGAL PERSONALITY
According to Business Bliss Consultants FZE a corporation is an artificial legal person that exists independently of its individual members. As such the company’s asset, debts and obligations are not the assets, debts and obligations of its shareholders, directors, employees.
According to Gayatri Ailani, separate legal entity is a legal concept which acknowledges that a company is an independent entity distinct from its owners, shareholders, and directors. Therefore, in the eyes of the law, a company is a person and has legal rights and obligation just like any individual.
IMPORTANCE OF SEPARATE LEGAL PERSONALITY
- Separate legal personality has overtime be notable for encouraging investments. According to Andrew Freiman running a business is a always a risk. The fact that the liability of investors is limited thereby protecting their personal asset encourages investment.
- Another importance of separate legal personality is its perpetual existence. According to Gayatri Ailani a company continues to exist even if its owners or shareholders change over time.
- A company can build a strong brand reputation that is separate from the reputation of its owners or shareholder.
THE SHIELD: FOSTERING BUSINESS AND LIMITING LIABILITY
The existence of limited liability
The main function of doctrine of separate legal personality is to serve as a shield which protects investors who invest in the company and the run the company. According to Adam Hayes, without limited liability as a legal precedent in the case of Salomon v Salomon, many investors would have been reluctant to invest in any company as the creditors of the company and other stakeholder could have claimed the asset of the investors would the company loss more money than it has.
This doctrine of limited liability prevents the financial exposure of shareholders exclusively to the amount of capital they have contributed or agreed to contribute to the company. In pursuant to section 27(4) CAMA 2020 it provides that the memorandum of association of a company limited by guarantee shall also state that each member undertakes to contribute to the asset of the company in the event of its being wound up while he I a member or within one year after he ceases to be a member for payment of debts and liabilities of the company, and of the costs of winding-up, such amount as may be required not exceeding a specified amount and the total of which shall not be less than 100,000 naira.
According to section 117(1) CAMA 2020 It provides that prior to the events of the winding up of a company, a member of a company with shares is liable to contribute the balance, if any, of the amount payable in respect of the shares held by him in accordance with the terms of the agreement under which the shares were issued or in accordance with a call validly made by the company pursuant to its articles. Section 117(4) CAMA 2020, went further to provides that in the event of a company being wound up, every present or past shall be liable to contribute to the assets of the company to an amount sufficient for payment of debts and liabilities and for the costs, charges and expenses of the winding-up but subject to the following:
- Section 117(4)(c) in the case of a company limited by shares, no contribution is required from any member or past member exceeding the amount, if any, unpaid on the shares in respect of which he is a liable as present or past members.
Past members here includes the estate of a deceased member and were any person dies after becoming liable as a member, such liability shall be enforceable against his estate section 117(5) CAMA 2020.
Perpetual succession
According to Sarthak Pattnalk any adjustment in participation of a company does not affect the status of the company, death, insolvency, insanity and so forth of any member from a company does not influence the progression of the company. Thus, the life of the company does not rely on the life of its member.
Ability to issue debentures
According to section 91 CAMA 2020 a company may borrow money for the purpose of its business or objects and may mortgage or charge its undertaking, property and uncalled securities whether outright or as security for any debt, liability or obligation of capital, or any part thereof, and issue debentures, debenture stock and other the company or of any third party. In conclusion because a company is a separate legal personality, it can borrow money, issue debentures and other securities, create charges over its asset and liabilities.
EXCEPTION TO SEPARATE LEGAL PERSONALITY
The courts began to recognize the abuse of this privilege of separate legal personality by directors or shareholders and the need to create an exception emerged. One exception to this principle of separate legal personality is piercing the corporate veil. Which developed through common law which mandates the court to pierce the veil and remove the protection that is the shield that was afforded to shareholders and directors.
The court in the case of Botha v Niekerk has resolved that what would necessitate the piercing the veil is where there had been unconscionable injustices of the separate legal personality. The court in the case of Cape Pacific Ltd v Lubner Controlling Investments ltd and others having rejected the test in Botha v Niekerk favored a more flexible approach ruling that the piercing of the veil is dependent on the fact of the case and therefore there is no closed list of categories in which court will pierce the corporate veil.
In Prest v Petrodel Resources Ltd the court held it has the power to ignore the separate legal personality of a company if:
- There is no other legal method of achieving an equivalent result.
- The structure of the company is used to evade a legal liability that the owner of the company would have otherwise incurred but for the use of the company structure.
The doctrine of separate legal personality, while designed to foster legitimate business and protect individuals, can indeed transform into a “piercing sword” when abused. This transformation typically occurs when individuals or entities exploit the legal separateness of a corporation (or other legal person) to engage in fraudulent activities, evade responsibilities, or achieve illicit gains. This abuse often leads to courts “piercing the corporate veil” to hold the individuals behind the entity personally liable.
HOW LEGAL PERSONALITY BECOMES A PIERCING SWORD:
Fraudulent Misrepresentation and Deceit: in the case of Petrodel resources ltd v Prest (2013 UKSC 34 the UK supreme court introduced two principles to rein in the overuse of the doctrine and the two principles are the evasion principles and the concealment principles. The evasion principle speaks of when the company is used to frustrate legal rights or obligation. In the case of Motor Co Ltd v Horne [1933] the court disregarded the corporate entity when Mr Horne set up a company to circumvent his contractual obligation under a non-compete clause.
The concealment principles talk about where the company’s separate personality is used to hide the true nature of transactions or relationship. A criminal organization creates a web of offshore companies to move illicit funds, making it extremely difficult for law enforcement to trace the money back to the individuals responsible.
Undercapitalization and Reckless Trading
Under this heading, a company is incorporated with insufficient capital to meet its foreseeable liabilities, indicating a reckless disregard for potential creditors. The legal personality shields the owners from personal liability even when the company’s financial structure makes failure almost inevitable. For instance, where a construction company takes up big project with minimal capital and then goes into bankruptcy leaving subcontractors and suppliers unpaid. The owners may have intentionally undercapitalized the company to limit their personal exposure.
CONCLUSION
The doctrine of separate legal personality, which seemed as a shield for individuals and entities, safeguarding assets of investors, limiting liability, can be used to perpetrate fraud, evade obligations etc.
