The general rule concerning companies is that a company is an artificial person,
separate and distinct from its directors and shareholders. Neither the directors
nor shareholders are personally liable for the company's defaults (safe in unique
narrowly defined circumstances which form specific exceptions to the general
rule. The general rule dated back more than a century and was set out in Salomon
v Salomon & Co's celebrated English case.
When a company is eventually registered, and the certificate of incorporation is
issued, the company becomes a legal person in law by the name contained in its
Memorandum of Association. As a legal person, the company becomes separate
and distinct from its members. However closely associated or controlled by those
members. It exists as a person and does all its things as any legal person. It cannot
be regarded as the property of the members.
Conversely once registered, a company becomes a separate legal person in law.
As a legal person, it can own property and conclude contracts, the shares held to
represent the company's interest, and their legal rights and duties are laid down
in the company's constitution. The shareholders as owners of the company are
not responsible in their capacity as shareholders for the company's day-to-day
running; that is the task of management. Once a company is registered, there is a
veil between the company and its members. This veil acts as a curtain between
the company and its members. By following this principle, the courts, in most
cases, have refused to go behind the curtain and see who are the natural persons
composing the company. However, sometimes, the necessity of the situation may
compel the communities to disregard the corporate entity and look to individual
members who are real beneficial owners of all corporate properties. This means
that the courts have at times tended to pierce the veil of incorporation in order to
make members personally liable and not the company. This is known as 'lifting of
the corporate veil.'
In Salomon v Salomon & Co, Salomon transferred his own company to make
boots and shoes. The company bought the business for £39,000 and issued shares
and a debenture for £10 000 secured by a floating charge on the assets. The
business became insolvent, and the trade creditors argued that the company and
Salomon were the same. Consequently, they claimed, his debenture was void
since a man cannot be a creditor of himself. Lord McNaghten held that "The
company is at law a different person altogether from the subscribers and though
it may be that after incorporation the business is precisely the same as it was
before, and the same persons are the manger, and the same hands receive the
profits, the company is not in law the agent of the subscribers or trustee of them.
Nor are subscribers as members liable, in any shape or form, except to the extent
and in the manner provided by the Act".
However, the doctrine's application has in certain situations led to injustice, and
the courts have disregarded by considered a device known as lifting the veil of
incorporation. In such a situation, the law looks at the people behind the
company rather than the veil of incorporation. Piercing the veil is, in a way, an
exception to the doctrine of corporate personality. It refers to a process where
the veil of incorporation can be disregarded to look at the individuals behind the
company: the shareholders and directors, personally liable for wrongs done for
debts and liabilities incurred by the company or in the name of the company. The
courts will lift the corporate veil where it is essential to secure justice, where it is
in the public interest to do so, or where it is for the benefit of revenue. The veil
may also be pierced to protect shareholders and third parties dealing with the
company. Whilst the veil is effective, it has been ‘raised’ by the courts where it has been deemed
relevant. The courts have been notoriously unwilling to establish clear rules as to when the veil will be
lifted.
However, the company must not be established to commit some fraud (Jones v Lipman) or to attempt to
circumvent contractual agreements or the veil will be lifted to identify the true nature of the
undertaking (for example a ‘sham’ company - Gilford Motor Co. Ltd v Horne).
In conclusion, ever since the case of Salomon, the Courts of law have continued to
uphold the doctrine of corporate personality that is a company, once formed
becomes a separate legal entity from its members which can sue and be sued in
its name, it can contract in its name, is liable for its debts among others.
Nevertheless, the application of the doctrine has led to injustice in certain
instances, and the courts have disregarded it; it is important to note that the
company's legal personality may be disregarded in certain circumstances by a
device known as lifting the veil of incorporation. This may occur when the device
of incorporation is used for some illegal or improper purpose. The court may
disregard the principle that a company is an independent legal entity and lift the
veil of corporate identity so that if it proved that a person used the company he
controls as a 'cloak' for an improper transaction, he might be made personally
liable to a third party.