This article has been written by Ms. Akshita Garnaik, a 4th year law student of XIM University, Bhubaneswar.
INTRODUCTION
A “legal person” is a person recognised by the law and is considered as a separate legal entity. The entity has its own legal rights and obligations apart from the people who run and/or won the business. The idea of a company’s corporate personality, sometimes referred to as its separate legal entity, asserts that the organisation is separate from its constituents. A corporation operates in its own name, has assets that are different from those of its members, and does not have the relationship of trustee or agency with its members.
An entity with separate legal status is a company. The corporation maintains its operational distinction by registering with the state and using ownership papers and transactions. There are several different types of companies: professional, small, and personal service businesses. A business must register with the state in order to function, with the exception of sole proprietorships. An organisation is not implied to be a distinct legal entity just because it is registered with the state.
Another unique feature of an LLC is that its owners, or members, are only accountable for the money they have contributed to the business.
An individual proprietorship is not a separate legal entity. The owner of the company and the person in charge of running it together make up a sole proprietorship. The financial and legal obligations of the company and the individual are combined.
It is possible to legally form any kind of business, but the main goal is to separate the obligations of the company from those of the individual owner (s). Liability for debts and lawsuits resulting from negligence or illegal activity may apply to both individuals and companies.
In the case of Salomon v. Salomon & Co. Ltd. (1897) A.C. 22, the circumstances involved Mr. Salomon operating a boot-making business as a sole proprietorship. As his business prospered, he opted to incorporate it into a company, with himself, his wife, his four sons, and his daughter as members. Mr. Salomon held shares and debentures with a floating charge, providing security against the company’s debts and making him one of the secured creditors. During the company’s winding-up due to business failure, he contended that, as a secured creditor, he should be prioritized over unsecured creditors for payment. In the aforementioned instance, the official liquidator declared the company a sham, defining it as a corporation existing solely on paper to hold assets under its name without engaging in actual business activities. The unsecured creditor contended that he was entitled to hold the company’s members responsible for settling the debts and argued that the corporation acted as his agent.
However, the House of Lords ruled that the corporation is entirely separate from its members, functioning as a distinct legal entity. It neither serves as a trustee nor an agent for its directors, managers, or members. The law recognizes the company as a separate and artificial legal entity. Thus, the distinct legal identities of the company and its members, known as their corporate personalities, were firmly established in this case.
The circumstances of a different case, Lee v. Lee’s Air Farming Ltd. (1961) A.C. 12 (P.C.), stated that Mr. Lee had Lee’s Air Farming Ltd. established with the intention of operating the aerial topdressing business. Mr. Lee being the company’s primary pilot, was a director, the owner of one share, and a salaried worker. Unfortunately, an aircraft crash claimed his life while he was working. Given that Mr. Lee passed away while he was employed, his wife filed a claim for reimbursement from the corporation. Because an individual cannot be both an employee and employer at the same time, the corporation contested the claim, arguing that Mr. Lee was not an employee.
As per the theory of separate legal entity, the Privy Council determined in the aforementioned case that Mr. Lee and his company were two distinct persons; hence, Mr. Lee’s wife’s claim for compensation is legitimate. Any corporation that adheres to the corporate personality of a company views itself and its members as two distinct individuals.
In the case of Macaura v. Northern Assurance Co. Ltd (1925), the appellant, Mr. Macaura, sold a timber estate he owned in Northern Ireland to a Canadian milling concern in exchange for shares in the company. The appellant received 42,000 fully paid £1 shares, granting him total ownership. In addition, he owed £19,000 to an unsecured creditor. Shortly after the appellant bought fire insurance coverage for the timber in his own name, damage was caused by the fire. Due to the fact that Northern Assurance Co. was a separate legal entity and owned the timber, the company declined to pay the appellant’s request for damages under the terms of the insurance policy. The issue involved is that does the insurance provider have to pay for Mr. Macaura’s burn-related damages? The House of Lords decided that because Mr. Macaura’s relationship was with the corporation and not the commodity, he had no insurable interest in the timber, hence insurers were not liable under the terms of the contract. The owner of the company filed the application in this instance to remove the corporate veil, claiming to own the largest percentage of the shares. The Court held, however, that despite owning all of the shares, the shareholder is not the corporation and that none of the creditors of the business, including him, has any legal or equitable claim to the company’s assets.
BENEFITS OF SEPARATE LEGAL ENTITY
The idea of liability protection is crucial as the majority of people can’t offer the greater obligation assumed by a company. The term “corporate shield” or “corporate veil,” which implies that the company (or any separate entity) is protected from liability, serves as an example of a separate entity. If the corporation is a distinct entity, then that shield, or veil, cannot be broken. There are several situations in which this idea can be applied, such as:
Imposing personal accountability on shareholders for the decisions made by the company
Since the owners of the company are separate legal entities, creditors cannot pursue them.
Assets owned by businesses and individuals are combined.
The idea of independent legal personality supports the idea that a corporation, its directors, and its shareholders are separate legal entities and has a number of legal ramifications for enterprises.
Furthermore, the following aspects of this concept are advantageous:
Limited liability is a direct result of the company’s independent legal status; shareholders are not personally accountable for the company’s debts, but rather their liability is limited to the amount invested in the company’s shares. Unless expressly stated otherwise in the Act or the Memorandum of Incorporation, an individual is not liable for any debts or obligations of the company solely because they hold a position as a director, shareholder, or incorporator. This is reinforced by Section 19(2) of the Act.
The company, rather than its directors or shareholders, is the legal owner of its assets and properties.
A company with different legal personality can also be good from perpetual succession, which guarantees the firm’s ability to maintain its legal identity and survive changes in its membership.
THE SIGNIFICANCE OF AN INDEPENDENT LEGAL ENTITY AS A LEGAL NOTION
The firm is different from its owner because it is considered a separate legal entity. First and foremost, the company, not the owner, shareholders, or directors, is nevertheless liable for any offence. Given the crime it has committed, the firm ought to answer for it. Wholly responsible for the degree of their involvement in the business are its founders. According to this, lenders cannot collect the company’s stockholders’ personal belongings in order to pay off debts, and they are not fully responsible for any business debts. The taxation of investors’ earnings resulting from the company’s profit is also mandatory.
Owners of small and medium-sized businesses can reap several advantages by becoming SLEs.
Rights: Although it is not necessary for all business types, an individual with SLE status is able to protect their property rights and defend themselves in court.
Legal framework: Because SLE holders have more legal protection, the legal structure supports the existence of such entities. SLEs may be granted additional defence authority in situations involving financial misappropriation, judicial misconduct, or other illegal activities. It is as a result of their standing, which is distinct from that of the concerned firm.
Under the law, corporations are recognized as distinct legal entities. Moreover, business owners are solely responsible for paying taxes on their dividends, bonuses, and salaries. However, corporate taxes are structured differently from personal taxes, reducing the likelihood of double taxation.
Exemption: A distinct legal organization is exempt from the management of yearly filings, shareholder meetings, and routine maintenance. Additionally, SLEs bear no liability for the company’s outstanding invoices, preventing the freezing of employee assets to settle debts.
Operation: SLE status facilitates the establishment of a distinct organizational identity and ensures consistency, enabling business ventures to continue even in the event of the owner’s demise or removal. This status remains undisputed except through legal means. Consequently, the company’s intangible assets, including franchises, exclusive rights, reputation, and intellectual properties, become legally liable due to the “identifiable persona.”
COMPANIES THAT ARE NOT REGARDED AS SEPARATE LEGAL ENTITIES
Though they are recognised as separate legal entities, two types of commercial entities exist that are not:
Sole proprietorships –
There is no separate legal body for sole proprietorships. This suggests that your personal and business commitments and assets are the same. The debts and liabilities of the business could be held directly against you.
Partnerships –
There are different kinds of partnerships, and your company’s choice will dictate the legal obligations of each kind. The many types of partnerships and the liabilities that go along with them are as follows:
General Partnership
In a general partnership, each partner has the same level of financial and legal accountability for the company. Written agreements can be used to specify each partner’s obligation level.
Partnership with limited liability
Restricts the individual legal responsibility of each partner, protecting the other partners from legal action if one is sued. The likelihood of this type of collaboration is lower among those who are not involved in any concerns.
Limited Partnership
A limited partnership is created by merging general and limited liability partnerships. The debts of the corporation are legally and personally owed by at least one member. A silent partner is one or more partners whose only accountability is for their capital commitment in the business. Typically, silent partners don’t participate in the day-to-day management of the business.
LLC Partnership
Since LLC partnerships have several members, they are regarded as LLCs under law. The owners are viewed as distinct entities from the company because LLCs are a type of corporate structure for private enterprises.
SEPARATE LEGAL ENTITY OF A COMPANY
A foundational theory in corporate law, the principle of separate legal identity has been entrenched in our legal framework for a considerable time. As per Section 19(1)(b) of the Companies Act, 2013, a legal entity possessing a distinct legal persona is designated as a company. Section 1 of Companies Act, 2013, further delineates a company as a juridical entity incorporated under the Act. This recognition underscores the company’s capacity to acquire rights and assume obligations autonomously from its directors and shareholders, thereby affirming its legal personality.
The principle of separate legal personality comes into effect upon the registration when the company is incorporated, thus giving the business all of the legal authority and capabilities of an individual. However, this privilege is not absolute and can be curtailed in instances where a legal entity is unable to exercise such powers or where the Memorandum of Incorporation stipulates otherwise. Apart from the importance, both the legislative developments and common law have illustrated that this prerogative is subject to exceptions and it will not be justified in cases of abuse.
Before being said to as a Separate Legal Entity, the company must be duly incorporated and registered. Proper incorporation will provide the company a separate legal identity from its parent.
Directors: Since they are in charge of managing the business’s activities.
Employees: These are the real proprietors of the company.
Shareholder: Anyone who has bought stock in the company.
In the case of HL Bolton Engineering Co Ltd v. TJ Graham Sons Ltd. (1956), the Court of Appeal decided that, under certain conditions, a business can be compared to a living being. The brain and nervous system of an organisation sustain the body’s functionality in a manner similar to that of a live individual. It even has hands to operate it and follow the directives of the company’s directors. The bulk of the organization’s staff consists of agents and employees who work for the corporation, carry out their duties, and cannot be shown to represent the company’s opinions or intentions. There are also supervisors and executives who manage the company’s operations and represent the core organisational principles of the business.
The brain and nervous system of a firm serve the same purpose as those of a living individual in maintaining bodily functions. In order to operate and follow the directives of the company’s directors, it even has hands. Those who work for the firm, carry out their duties, and cannot be shown to represent the corporation’s opinions or intentions make up the bulk of the organization’s workforce. The company’s executives and supervisors are responsible for managing its operations and embodying the core organisational principles. The company views these executives’ ideas as its own, and the law recognises this.
In the absence of the concept of a distinct legal entity, businesses may have done a few things, including:
The business may have held all owners or employees of the company liable for the offence committed by any of them.
It is possible that they drafted contracts that held the company and the individual responsible.
Numerous agreements that are set incorrectly will exist if a company is a member of a group of companies.
Sometimes a person or the firm would want a certain legal matter. Proceedings in court may be based on any cause of action involves a party other than the party that is legally bound, including criminal misappropriation, claims for punitive damages, and breaches of fiduciary obligation.
CORPORATE VEIL
A legal concept that separates the identity of the firm from that of its members is known as the “corporate veil theory.” Consequently, any liability resulting from the actions of the firm is shielded from the members.
Thus, in the event that the company incurs debts or violates any laws, the members have corporate immunity and are not held responsible for their actions. In short, there is protection for the shareholders against the company’s conduct.
Upon registering, the company becomes an independent legal entity. Additionally, a Corporate Identification Number (CIN) is assigned to it. A veil, separates the corporation from the outside world in accordance with the notion of independent corporate existence. The concept, often known as the corporate veil doctrine, describes this unique corporate existence. The basis of the corporate type of organisation is the Corporate Veil.
LIFTING OF CORPORATE VEIL
The separate legal entity doctrine may not apply in this instance due to the potential for misuse, as business owners might engage in fraudulent activities while still profiting. Therefore, to prevent members from violating laws or conducting illicit operations under the guise of the company, safeguards are necessary. Without this doctrine, members might exploit the concept, necessitating the court to offer compensatory measures to those who rely on the separate legal entity defense.
Equally crucial alongside the theory of separate legal entities is the concept of piercing the corporate veil. Courts may reject the notion of a distinct legal entity for various reasons, and there are scenarios where the idea of separateness appears arbitrary. The court may issue rulings that challenge the notion of a distinct legal entity to uncover the individual behind the corporate facade and reveal the true nature of the enterprise. Scholars have categorized cases into distinct types to aid readers in evaluating the applicability of the separate legal entity doctrine.
An organization’s actions are those of the organisation. The Memorandum of Association (M/A) of the firm defines and limits its powers. The company’s founders and managers are expected to establish and operate the business honestly, in the best interests of the enterprise, and within the bounds of the corporation.
In instances where the corporate entity is abused to circumvent legal obligations or for personal gain, those responsible will be held liable, and the corporate structure may be disregarded. This practice, known as “lifting the Corporate Veil,” involves overlooking or disregarding the “Separate Corporate Entity” to search beyond surface appearances and examine the true intentions of the involved parties. In numerous scenarios, courts have the authority to lift the corporate veil.
SITUATIONS WHERE THE CORPORATE VEIL CAN BE LIFTED
- To assess the personality of the business- Occasionally, the courts have to decide if company is an enemy or an ally. The control test is done by the courts in such cases. Courts hardly ever penetrate the corporate veil unless the public interest is at stake. The court has the authority to look into a company’s potential adversary status, though.
- To shield income or evade taxes- For instance, in cases concerning tax evasion or avoidance, the court might opt to disregard the corporate structure. Consider a scenario where a company is utilized to dodge tax payments. In such instances, piercing the corporate veil empowers the court to uncover the true beneficiary of the business’s earnings and enforce the proper tax liabilities upon them.
- When attempting to evade a legal obligation- At times, to sidestep legal responsibilities, business members might establish a subsidiary entity. In these situations, piercing the corporate veil gives the courts access to what happens behind closed doors.
- Appointing subsidiaries as representative entities- Creating a corporation can occasionally be done to act as an agent or trustee for its constituents or another business. The company’s uniqueness is given up in these situations so that the principal can prevail. Furthermore, the company’s acts are the principal’s responsibility.
- A business established to break the law or commit fraud- In situations where a corporation is established with improper or unlawful goals, such dodging the law, the corporate veil may be penetrated.
CONCLUSION
The concept of a company functioning as a separate legal entity is paramount, emphasizing that a company is an artificial entity separate from its members. It underscores that a company’s assets should not be utilized for the personal gain of its members but rather for the benefit of the company itself. In cases where the corporate personality of a company is exploited, the law will pierce the corporate veil and hold members accountable for their actions.
In case of any breach of the contract terms, both parties reserve the right to initiate legal proceedings against each other, potentially leading to lawsuits filed and received by the business. The landmark Salomon v. Salomon & Co. case profoundly established the principle of a distinct legal entity, setting a precedent that has been applied in numerous subsequent cases. The concept of the veil of incorporation originated from the Salomon case; however, this doctrine is subject to several limitations aimed at preventing the abuse of limited liability protection. The veil of incorporation may only be pierced under specific circumstances, such as when the company’s primary objective is illegal or fraudulent, or to prevent dishonest or reckless trading. Courts retain the authority to disregard the corporate veil when deemed necessary.
REFERENCE
- This article was originally written by Rishi Pandey published on livelaw website. The link for the same is herein.
- This article was originally written by Taxmann published on taxmann website. The link for the same is herein.
https://www.taxmann.com/post/blog/6177/doctrine-of-corporate-veil-separate-legal-entity