Separate legal personality & limited liability

Once company has been incorporated or registered, it obtains a legal entity separate separate from the owners and the people running the company (i.e. directors). This means the company becomes a legal person that has rights and obligations, for example it can own property and assets, sue and be sued in its own right.

This article looks at how the fundamental principle of legal entity and personality first developed and how it compares to limited liability.

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Saloman vs. A Saloman & Co Ltd [1897] AC 22

A separate legal personality was principle that was first developed in the English case of Salomon Vs. Salomon & Co. Ltd. [1897] A.C. 22.

Mr Saloman formed a company called Saloman & Co Ltd. Mr Saloman loaned the company £10,000 in return for which he received a floating charge over the company’s assets. The business ran into difficulties and ultimately went into insolvence owing money to third party creditors.

The liquidator of the company claimed the floating charge should not be honoured and that Mr Saloman should be personally liable for the company’s debts.

The House of Lords held that Mr Saloman was not personally liable, and that the floating charge was valid, meaning that Mr Saloman was entitled to get paid ahead of the company’s unsecured creditors. The Company’s acts were its own acts, not those of Mr Saloman personally, even though he was effectively the only person involved in running the company. The House of Lords held that a one-man company (i.e. a company which only had one shareholder) was a legitimate creation provided it was validly formed and complied with the formalities required by law.

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Consequences

• The company can own its own property, as such it should be insured in the company’s own name.
• The company must enter into contracts in its own name.
• Employees will contract with the company and not any individual running the company.
• The company can borrow money and give security over its assets (it may borrow money from its own members or directors).
• A company is liable for its own debts; creditors cannot sue members or directors to pay off debts, or seize their personal assets.
• A company may sue and be sued in its own name.
• The company is taxed separately.
• The company has perpetual succession, meaning the company does not cease to exist just because a member ceases to be a member.

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Side-stepping separate legal personality

A separate legal entity is described as a “corporate veil” as it shields the shareholders or directors from the company. In some cases an individual may use the separate legal personality to conduct itself in an unauthorised way and avoid liability. An example of this occurring was:

1. “Piercing the Corporate Veil”

In Prest v Petrodel Resources Ltd [2013] UKSC 34 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.
• This was referred to by Lord Sumption as the “evasion principle”. On the facts this principle did not apply because Mr Prest had set up companies, to which the ownership of most of his property had been transferred, long before his marriage had broken down.

2. Guarantees

Lenders will often get around the principle of separate legal personality by demanding personal guarantees from shareholders when they enter into loan contracts. These will require, as a matter of contract, that the shareholder makes good any shortfall in the amount owed which the company cannot repay.

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Adams vs. Cape Industries [1990] Ch 433

• Cape Industries was a UK company who mined asbestos in South Africa and shipped it to a subsidiary company in the USA, NAAC.
• Employees of NAAC became ill with asbestosis and successfully obtained judgement against Cape in the USA.
• However, to enforce judgement in the UK, the claimants had to show that Cape itself was “present” in the USA.

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Outcomes

The court found that Cape was not present in the USA only its subsidiary NAAC was present, the claimant’s unsuccessfully tried to argue the following/;

• ‍The Agency Argument: Cape was present in the USA because Cape’s subsidiaries were acting as Cape’s agents. The courts rejected this argument finding that the NAAC was authorised to carry on its own business independent of Cape and was not merely acting as Cape’s representative.
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• ‍The Single Economic Unit Argument: As companies are separate legal persons, it is possible for them to own shares in another company. In such a situation, the owners of the parent company effectively have control over the subsidiary, thus in certain limited circumstances the law recognises this and treats the two companies as if they are not independent entities. The court held that this did not apply in Adams, holding that “there is no general principle that all companies in a group of companies are to be regarded as one”.
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• ‍The Corporate Veil Argument: The court held that this was not a situation in which the corporate veil could be pierced, holding that the defendants were perfectly entitled to structure their group so that legal liability would fall on another member of the group rather than the defendant company.

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Limited liability

A shareholder’s liability in the event the company is wound up is limited to any unpaid amount of the nominal value of his shares (s74(2)(d) Insolvency Act 1986.

• Shares in a company have a fixed legal monetary value
• Known as the nominal or par value
• When a shareholder buys shares in a company, normally he will pay for these in full. If a shareholder does so, he will have settled his liability with the company immediately.
• However, occasionally shareholders do not pay for the shares in full, and only pay part of the nominal value of the shares. If a shareholder does this, and the company is wound up, the company will demand the shareholder pay a sum equal to the unpaid amount of the nominal value of his shares.

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The opinions on this page are for general information purposes only and do not constitute legal advice on which you should rely.