The Doctrine of Separate Legal Personality

“The doctrine of ‘separate legal personality’, as embodied in Salomon v Salomon & Co Ltd [1897] AC 22, has been fatally undermined by the number of subsequent exceptions to it.” Discuss this statement, stating whether you agree or disagree, in whole or in part, and why.

Abstract

Comments on the doctrine of separate legal personality, a major principle in English company law, and the fear that the growing number of exceptions to the doctrine is fatally undermining it. Explores the doctrine and its main exceptions to assess the extent to which the exceptions undermine the doctrine of separate legal personality. Discusses whether the exceptions are in fact necessary to uphold the doctrine of separate legal personality.

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The doctrine of separate legal personality

The doctrine of separate legal personality is a fundamental principle of English company law essential to the act of incorporation. Upon incorporation a company gains an artificial legal personality, quite distinct from that of its members. The doctrine was established in Salomon (1897:30), where it was stated, ‘it seems…impossible to dispute that once the company is legally incorporated it must be treated like any other independent person with its rights and liabilities’. However, the courts are willing to lift the veil of incorporation and ‘set aside the separate legal personality of a company’ in certain situations (Birds 2009:62). As there are no general principles guiding the court in this area, the ad hoc nature of the practice has been criticised. This essay will consider whether the number of exceptions has fatally undermined the doctrine of separate legal personality.

Statutory provisions

Although the principles for lifting the veil of incorporation are not established, the circumstances under which the veil can be lifted are to a certain extent agreed. The separate legal entity doctrine will be discarded in cases of fraud or agency or where there is statutory provision (Case Comment 2012:3). Each instance will be considered in turn to explore whether they undermine the doctrine.

Under s.213 and s.214 of the Insolvency Act 1986 the veil of incorporation can be lifted and the separate legal personality of the company discarded. S.213 states that the veil of incorporation will be lifted in the event of fraudulent trading. Fraud is defined as ‘actual dishonesty, involving, according to current notions of fair trading among commercial men, real moral blame’ (Re Patrick and Lyon:790). Not only is this restrictive but the onus of proof is on the person seeking to rely upon it; suspicion is not sufficient. As this exception is hard to prove, it is not commonly used and cannot be said to fatally undermine the doctrine.

Under s.214, the veil of incorporation will be lifted if wrongful trading is proved. If the director knows that there is little chance of avoiding liquidation yet enters into new contracts, he will be held liable and cannot rely upon legal separation (Birds 2009:577-578). This is much to satisfy than s.213 and could be susceptible to claims that it undermines the doctrine of separate legal personality. Nevertheless, as directors are best placed to know the financial circumstances of the company, it seems right that they should not be able to rely on the doctrine of separate legal personality if they trade wrongfully and seek to hide behind the corporate structure.

Facade/Sham

The law will not allow a company to be used as a vehicle for fraud or illegality. If the company is being used as ‘a mere facade concealing the true facts’, the veil of incorporation will be lifted (Woolfson 1978:20). This principle was recently confirmed in Linsen v Humpuss (2012:682), where the CA stated that the veil will be pierced when it is being used as a facade.

In Jones v Lipman (1962), the defendant set up a company to try and escape current contractual obligations and similarly, in Guilford Motor Co v Horne (1933), the company was formed to breach a covenant (Mitchell:149). Consequently, the veil will be lifted where ‘the defendant company is the creature of the first defendant, a device and a sham, a mask which he holds before his face in an attempt to avoid recognition by the eye of equity’ (Jones v Lipman 1962:445). This is so, even if it is claimed that the ‘course of action is necessary to give legal effect to the “realities” of the business situation’ (Moore:194). It is clear that the court takes a strong approach against fraud, which is appropriate as it is important that the corporate structure is not used for unjust purposes.

Agency

In DHN v Tower Hamlets (1976), the court suggested that the doctrine of separate legal personality could be discarded between groups if the subsidiary and parent companies were a single economic entity. While the single economic entity argument has been praised by some, it has been criticised. The single economic entity argument would have seriously undermined the doctrine by making redundant the distinction between parent and subsidiary companies. It would also focus on economics to the detriment of legal doctrine (Bank of Tokyo v Karoon 1987:64). Consequently, Adams v Cape (1990:532) established that the separate legal personality of corporate groups can be disregarded only if a subsidiary is merely an agent of the parent company because ‘there is no general principle that all companies in a group of companies are to be regarded as one’.

Has separate legal personality been undermined?

It could be argued that the exceptions by their very nature undermine the doctrine because parliamentary intention to pierce the veil would have been clearly expressed (Dimbleby v NUJ 1984). However, as legislators cannot foresee every circumstance the courts must strive to prevent the doctrine from being used in a way that was clearly not intended by parliament.

A further argument is that the principles for lifting the doctrine are ad hoc and confused which undermines the doctrine. There is no consistency and subsequently, there is uncertainty as to when the doctrine will be disregarded. However, there are some principles the courts will adhere to. Firstly, separate legal personality cannot be ignored in the interests of justice alone (Adams v Cape 1990:536). Secondly, impropriety must be proven before the veil is lifted (Ord v Belhaven:457). Nevertheless, it is important to maintain an element of flexibility within this area, to equip the court to deal with novel situations.

The exceptions ensure that people cannot hide behind the company to commit what would otherwise be an offence. If the veil could not be lifted in these circumstances, the accusation would be that incorporation is being used as a cloak for wrongful behaviour, which fatally undermines the doctrine. Perhaps paradoxically, the exceptions appear to uphold the underlying principles of the doctrine rather than fatally undermine it.

References

1. Adams v Cape Industries [1990] Ch 433
2. Anon, 2012. Case Comment Chandler v Cape Plc: is there a chink in the corporate veilHealth and Safety at Work, pp.1
3. Bank of Tokyo v Karoon [1987] AC 45
4. Birds, J. Et al. 2009 Boyle and Birds’ Company Law 7th Edition, Bristol: Jordans Publishing Ltd
5. DHN Foods v Tower hamlets LBC [1976] 1 WLR 852
6. Dimbleby & Sons Ltd v National Union of Journalists [1984] 1 All ER 751
7. Guilford Motor Co v Horne [1933] Ch 935
8. Insolvency Act 1986 (c.45) London: HMSO
9. Jones v Lipman [1962] 1 All ER 442
10. Linsen International Ltd v Humpuss [2012] 1 BCLC 651
11. Mitchell, G. 2012. Piercing the corporate veil to impose contractual liability on a director. Journal of International Banking and Financial Law, vol.3, pp.149
12. Moore, M. 2006. “A temple built on faulty foundations”: piercing the corporate veil and the legacy of Salomon v Salomon. Journal of Business Law, pp.180
13. Ord v Belhaven Pubs Ltd [1998] 2 BCLC 447
14. Re Patrick and Lyon Ltd [1933] Ch 786
15. Salomon v A Salomon and Co Ltd [1897] AC 22
16. Woolfson v Strathclyde [1978] 2 EGLR 19

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