Company as a Separate Legal Entity PDF

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Lecture Notes for Private Law Aspects of Company Law...

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The Company as a Separate Entity Overview -

Introduction to the different actors The function of company law and sources Private law capacity of companies Agency and vicarious liability (will not be examined) Corporate and individual liability Limited liability

The Function of Company Law and Sources The Structure of Company Law -

Companies Act 2006 Insolvency Act 1986 Model Articles for Private Companies (internal rules binding on company and shareholders under s33 CA 2006) Case law interpreting legislation and arising at common law Key influence of European Directives (especially on public companies) Variety of other instruments (Listing Rules, Corporate Governance and Stewardship Codes

The Role of Company Law -

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Directors and managers manage the company’s business with broad discretion (Art 3 MAPC); courts do not review good faith business decisions (s172 CA 2006) Majority shareholders have significant powers in general meeting, including in particular to amend the constitution (s21 allows amendment by special resolution – 75% majority); they can also appoint and remove the board (Art 20 MAPC and s168(1) CA 2006) The powers held by directors and majority shareholders make the following vulnerable: minority shareholders; creditors; other stakeholders The task of company law is to achieve an adequate balance between the need for efficient decision-making (which justifies discretion, majority rule and facilitation) and the requirement of fairness (which justifies protection of these other interests through regulation).

Life of a Company -

Registration and incorporation Capitalisation and issue of shares Appointment of director(s) Debt finance? Trading: contracts etc Distribution of profits or reinvestment? Disclosure: filing at Companies House and publication of accounts Success or insolvency?

The Company as a Separate Entity

The Progression of Business Forms over Time -

Sole Trader Partnership Private limited company (‘Ltd’) Public limited company (‘plc’) Listed public limited company Global corporate group/network

Sole Trader -

A natural person carrying on business on their own account No formalities required but sole traders have privacy No separation of personal and business assets No limited liability – any limitation of liability must be done expressly by contract Sole trader pays income tax on income but can deduct expenses

Partnership -

Two or more persons carrying on business in common with a view to profit (s1, Partnership Act 1890) Each partner is an agent of the others and can bind the partnership Hence fiduciary duties to each other Partnership is not a separate legal entity No public registration and disclosure required Partners have unlimited liability unless limited by contract – no separation between personal and partnership assets

Limited Liability The Consequences of Limited Liability and Incorporation -

Limited liability (shareholder liability is limited to the money they have paid into the company in return for their shares) Separate legal entity (the company is a legal actor distinct from its shareholders and directors) They coincide in the private limited company, but this is not inevitable: for example, it is possible to have a separate legal entity but for the law to make the shareholders bear unlimited liability for its debts

Separate Legal Personality -

Companies Act 1862 gave companies full separate legal personality for the first time, automatically upon registration:

The Company as a Separate Entity It required a minimum of seven members (shareholders) before registration would be permitted o Since 1992, single member companies are permitted, so no requirement of an association of shareholders behind the entity, nor of capital raising (a £1 share is sufficient) o Why would you want to do this? Is it legitimate? Notion that companies (hence the name) were incorporated partnerships (emerging out of the historic joint stock company form) o

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Salomon v Salomon & Co Ltd [1897] AC 22 -

Main question for the courts was whether Aron (secured creditor) could take priority In both first instance and Court of Appeal, courts decided that Aron should be personally liable for the companies debts. However, they both came to the conclusion using separate legal devices. o First Instance – Company was the creation of Aron, and therefore should be liable for the liability of the company o Court of Appeal – Company held the business on trust for Aron. The company is the trustee and Aron is the beneficiary.

Broderip’s Challenge -

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Could Aron Salomon really take priority over unsecured creditor? Broderip, who had become a secured creditor after AS transferred some debentures to him, sought payment. The liquidator tried in various ways to improve the position of the unsecured creditors First instance: Broderip’s claim was successful, but trial judge allowed liquidator to amend claim to say that the company was the agent of AS, so AS had to indemnify it, and made an order CA: Broderip v Salomon [1895] 2 Ch 323 o A mere scheme or device to carry on business with limited liability, whilst in essence he was carrying on business as a sole trader, so the company held business on trust for AS (Lindley, LJ)

Aron Salomon’s Victory -

HL: Salomon v. Salomon & Co Ltd [1897] AC 22 o Company formed in line with legislation a separate person, not an agent or trustee for AS o Therefore, AS claim could take priority over unsecured creditor o In any event, creditors were on notice that S&Co Ltd was a separate legal entity (‘they had full notice that they were no longer dealing with an individual’ – Lord MacNaghten), could have found information about the secured loan, and could have protected themselves under the Act (Lord Watson) o It is in the nature of incorporation that it allows shareholders to carry on business with limited liability (Lord Herschell), and the use by the CA of the trust device would have far reaching implications for many companies

The Company as a Separate Entity -

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Lord Halsbury: ‘Either the limited company was a legal entity or it was not. If it was, the business belonged to it and not to Mr Salomon. If it was not, there was no person and no thing to be an agent at all; and it is impossible to say at the same time that there is a company and there is not.’ Lord Watson: ‘In my opinion, the statute casts upon them [the unsecured creditors] the duty of making inquiry in regard to these matters… the apathy of a creditor cannot justify an imputation of fraud against a limited company or its members, who have provided all the means of information which the Act of 1862 requires; and, in my opinion, a creditor who will not take the trouble to use the means which the statute provides for enabling him to protect himself must bear the consequences of his own negligence.’ o After the incorporation, the information has been made available to creditors. Hence, it was their job and responsibility to find out all the information and take any protections themselves.

The Implications of the Company as a Separate Legal Entity -

Property owned by company does not belong to its shareholders: Macaura v Northern Assurance Co Ltd [1925] AC 619 Company can make contracts (including loan or employment contracts with directors and shareholders – see Lee v Lee’s Air Farming [1961] AC 12) Company can commit torts Wrongs done to company (e.g. breach of contract, tort, breach of duty) give company not shareholders a cause of action Company is a taxpayer, liable for corporation tax

Benefits of the Corporate Form -

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Perpetual succession (shareholders can change, although transferability of shares governed by articles) Two-way ‘asset partitioning’: company creditors cannot sue shareholders, and shareholder creditors cannot sue company Cheaper access to capital (Encourages investment and expansion): o ability to grant fixed and floating charges, making debt capital cheaper; and o possibility of separation between management and risk-bearing, allowing shareholders to diversify risk, and making equity capital cheaper Commitment of equity capital: it cannot normally be returned to shareholders, and so is available for the business and, in theory, for creditors

How do Companies Act Acting through Corporate Organs

The Company as a Separate Entity

When the law attributes an act to a company (per Lord Hoffmann in Meridian)

Company Capacity: Protection of Third Parties -

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Company capacity used to be limited by its objects clause, and action beyond its objects was ultra vires and void, and therefore not binding on third parties (who had ‘constructive notice’ of a company’s objects) Policy now is that third parties should not have to concern themselves with the company’s capacity Most companies now have unlimited objects (unless they include an objects clause within their articles : s31(1) CA 2006) and so have unlimited capacity s39 CA 2006: Third parties can assume that the company has capacity to enter into contract, regardless of anything in its constitution However, a director who ignores a limitation of the company’s objects may be in breach of duty and liable to the company under s171(a): see topic 4

The Company as a Separate Entity Authority: Protection of Third Parties -

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Further policy that third parties dealing with (that is, entering a transaction with) the board or an agent authorised by the board should not have to make further inquiries as to their authority Common law indoor management rule allowed third parties to assume that, where there was a power to appoint agents, that power had been exercised in accordance with any conditions (Royal British Bank v Turquand (1856)) New statutory rules go further and allow third parties to assume that there are no limits on the power of the board to bind the company s40 CA 2006: A person dealing with a company in good faith can assume that the directors have power to bind the company, and that the directors have power to authorise others (e.g. agents) to bind the company (i.e. they can assume that there are no limits on these powers contained in the constitution) o Good faith is very broad: see s40(2)(b), and even includes a situation where the third party knows the directors have no authority; company would need to show something more – Hannigan suggests knowledge of an improper purpose or conflict of interest or being put on inquiry by the circumstances and failing to inquire Directors are excluded from s40 (s41 CA 2006: If the person dealing with the company is a director or parent company, and they rely on s40 for its validity, the company can rescind the transaction) as are shareholders (because they are not third parties: see obiter EIC Services Ltd v Phipps (2004, CA))

Agency and Vicarious Liability Vicarious Liability -

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Company is liable for torts committed by agents or employees within the scope of their authority or employment, whether or not company authorised them: Lloyd v Grace, Smith & Co [1912] AC 716 Company will be liable where there is a ‘sufficiently close connection’ between wrongful acts and the activities the employee was employed to undertake: see Lister v Hesley Hall Ltd [2001] 2 All ER 769 Employee or agent will have concurrent personal liability

Personal Liability of Directors for Negligence -

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Courts are reluctant to hold directors personally liable for negligent misstatement when contracting on behalf of company: see Williams v Natural Life Health Foods Ltd [1998] 1 BCLC 689. The starting assumption is that, even where a single member company, the director assumes responsibility only on behalf of the company, so a director will only be personally liable for negligent misrepresentation if he assumes personal responsibility for the advice, and the claimant reasonably relies on that assumption; in this case, the sole director never assumed personal responsibility, he was always acting on behalf of the company This case reinforces the Salomon principle: people set up companies so that the risk of loss falls on the company rather than on them, and courts are reluctant to allow third parties to get around separate entity principle by using negligence to make directors personally liable

The Company as a Separate Entity Personal Liability of Directors for Deceit -

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Director will be personally liable for an intentional tort such as deceit (see Standard Chartered Bank v Pakistan National Shipping Co (No 2) [2003] 1 BCLC 244, HL) provided that the director made a personal representation (e.g. that the company is in a position to pay). There is no requirement of an assumption of responsibility here (this is deceit, not negligence liability for pure economic loss) Where a director commits the tort of deceit, the company will also be vicariously liable for that tort (presumably as long as the director is also an employee e.g. a managing director and acting within scope of employment) Companies may provide liability insurance to directors; deceit claims are increasing Greater willingness to hold directors liable for fraud reflects clear policy of deterring fraud

Company Action Against Director -

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If the company is held vicariously liable, it can claim a contribution (an indemnity if it has no knowledge of wrongdoing) from the director (Civil Liability (Contribution) Act 1978, s1), or can sue the director for breach of fiduciary duty or negligence. Similarly, companies may be able sue employees or agents for breach of contract

Limited Liability The Principle of Limited Liability -

s3(1) ‘A company is a “limited company” if the liability of its members is limited by its constitution. It may be limited by shares or limited by guarantee.’ s3(2) ‘If their liability is limited to the amount, if any, unpaid on the shares held by them, the company is “limited by shares”.’

Limited Liability in Corporate Groups and Networks -

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Companies can own shares in other companies (their ‘subsidiaries’ where they own all or a majority of the shares) Subsidiary defined in s1159(1) CA 2006 (this is primarily for the purpose of determining when consolidated accounts are required): majority of voting rights; right to appoint majority of board; control of majority of votes through contract (eg shareholder agreement); subsubsidiary Companies can also be connected through long-term contracts

Why Corporate Groups? -

Asset partitioning (creditors of one company cannot sue another company) Tax minimisation/avoidance (where is the subsidiary located for tax purposes?) Business organisation (different entities can carry on different parts of the business) Risk management (limited liability creates firewalls protecting group assets) Financing (can be organised centrally)

The Company as a Separate Entity Limited Liability: Privilege or Default Term -

Used to be considered a privilege, with public disclosure the price Now economists argue it is a simply a term inserted into contracts by default: other parties can bargain for personal guarantees from director-shareholders or from parent company BUT: what about tort creditors, and what about small creditors?

Since Prest, ignoring separate legal personality of the company is referred to as ‘piercing’ the corporate veil If court ignores separate legal personality (‘pierces’ the veil), this can have two consequences: shareholders no longer have limited liability (and orders against company are binding on shareholders) those with claims against shareholders can enforce against company (ie asset partitioning comes to an end) Alternatively court can look behind the corporate veil and use private law remedies to make an order against the company and its controller (‘lifting the veil’) Witting argues at 10.9 that piercing the veil should be viewed as an exception to limited liability, with shareholders made liable in defined circumstances, for the debts of the company. He argues that this is better than viewing the court as ‘ignoring’ the existence of a validly formed company. But in those rare (if any) cases where the court has pierced the veil, they identify the company with its controller (an example of fraud unravels everything?) The grounds for piercing corporate veil: pre-Prest Very narrow approach taken to piercing by SC in VTB and Prest v Petrodel The courts are reluctant to ignore separate legal personality and make the shareholders liable for the debts of the company. The rationale is that everyone assumes that the company is a separate legal entity, and has sufficient information to allow them to contract around it (for example by seeking personal guarantees from the directors). Hence legal certainty prevails. But tort creditors have no opportunity to bargain: should they be allowed to pierce the corporate veil and hold the shareholders (who profit from the company’s activities) liable? This will be discussed in topic 6. On the other hand, the courts were apparently more willing to ignore separate personality to prevent shareholders evading their own obligations by hiding behind companies. Agency (i.e. the company was the agent of its shareholders) Mere control is insufficient: Salomon Courts were willing to imply from the facts in the past: Smith Stone and Knight v Birmingham [1939], but now will make shareholders liable only where there is express agency agreement: Adams v Cape Industries [1990] Preventing Injustice (i.e. shareholders should be liable for wrongs of company to prevent injustice)

The Company as a Separate Entity Injustice alone is insufficient, some impropriety is required: Adams v Cape Industries In DHN Foods v Tower Hamlets London Borough Council [1976], a court allowed a company to recover compensation for disruption of the business of its subsidiary: confined to its facts (it was an interpretation of a particular statute) by Adams v Cape Industries Fraud (façade or sham) by shareholders Improper use of company to evade existing (contractual) obligations: Gilford Motor v Horne [1933]; Jones v Lipman [1962] Use of company to divert money in breach of fiduciary duty: Trustor AB V Smallbone [2001]; Gencor ACP V Dalby [2000] BUT, in each case court made order against wrongdoer and company (see Yukong Line Ltd of Korea v Rendsburg Investments [1998] 2 BCLC 485 per Toulson J), hence court respects corporate veil but recognises that the company is involved in the illegality (in language of Prest, this seems to be lifting not piercing the veil). •

The Supreme Court held • M’s misrepresentations did not justify piercing the veil to make him party to and personally liable for the company’s contractual obligations • Lord Sumption opposed to piercing the corporate veil to create new liability that did not otherwise exist • M did not use N to evade an existing obligation to V • V had another remedy against M for misrepresentation

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Observations • V had not required M to guarantee R’s obligations • V could sue M in tort for deceit • However, the relevant actions occurred in Russia • A majority held the UK courts did not have jurisdiction

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As part of a matrimonial dispute, Mrs P wanted certain properties, owned by various companies, to be treated as property of Mr P, so that she could have them transferred to her

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Mr P refused to provide information about the control of companies or how the properties were acquired, and obstructed the court proceedings

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Court ultimately ruled that the properties were held on resulting trust for Mr P because of how th...