Principle of Separate Legal Entity of Company
This article explains the principle of separate legal entity of a company and when this principle is not applicable (doctrine of lifting/piercing of corporate veil).
Introduction —
To understand the principle of Separate Legal Entity of Companies, it is essential first to understand what a company is. There are multiple definitions of what a company is, Section 2(20) of the Companies Act, 2013 defines “a company incorporated under the Companies Act, 2013 or any other previous company law.” This is the definition provided in the legislation. Prof. Haney defines “A company is an artificial person created by law, having a separate legal entity, with a perpetual succession and a common seal.”
So, a company is an artificial person, i.e., it is recognized to be a person as per law and created by law, which means it can enter into contracts, sue and be sued, and buy and sell property in its name. It has a separate legal entity, i.e., the members of the company and the company are two distinct persons, and we will see this concept in detail in the further sections of this article. A company has a perpetual succession meaning that the joining, leaving, insolvency, or death, of any member, will not affect the company. The common seal explains that since a company is an artificial person, it cannot hold a pen and sign documents, therefore, it has a common seal that has the name of the company engraved in it in legible characters and uses it as a stamp for signing any important document.
Though a company is an artificial person it does not hold citizenship as per the Constitution of India and the Citizenship Act, 1955 only a natural person can be a citizen. But a company has nationality (eg: Indian Company, Korean Company), domicile (the place where the company is registered and has a registered office), and residence (the place where the company operates).
Separate Legal Entity —
Separate legal entity, also known as the corporate personality of a company, is a concept that states that the company is distinct from its members. A company acts under its own name, its assets are distinct and separate from those of its members and there is no concept of agency and trustee between the company and the members.
The company cannot hold the shareholders liable even if any shareholder is holding all of its shares. This depends on the fact whether the company is a limited company or an unlimited company. If the company is a limited company then the shareholders can be called for payment during the process of winding up to pay the amount which is yet to be paid by them (Limited by Shares) or to pay the amount which was guaranteed by the shareholders as stated in the Memorandum of Association (Limited by Guarantee). In an unlimited company, the members need to even sell off their personal assets during winding up to settle liabilities, but such companies rarely exist.
In simple words, a company has a distinct identity that separates it from its members and makes it independent of its members. The members cannot hold the company liable if the members have any personal debts. The members do not have any right to claim ownership of the assets of the company and nor can the company claim any ownership over the personal assets of the members.
The concept of a Separate Legal Entity was strongly established in two cases, Salomon v. Salomon & Co. Ltd. and Lee v. Lee Air Farming Ltd. In both these cases, the court held that a company is distinct from its members.
In the case of Salomon v. Salomon & Co. Ltd. (1897) A.C. 22, the facts of the case were that Mr. Salomon had a boot-making business which was a sole proprietorship. Soon after his business started to make a good profit, he decided to make it into a company and the members of the company were himself, his wife, his 4 sons, and his daughter. Mr. Salomon was a shareholder and debenture holder at a floating charge, i.e., secured against the debt of his company which made him one of the secured creditors. During the time of winding up due to the failure of the company's business, he claimed that being a secured creditor he must be paid prior to the claims of the unsecured creditors. The official liquidator claimed the company to be a sham company (meaning a company just on papers carrying out no business but only for the purposes of holding assets of members in its name). The unsecured creditor further claimed that the company was an agent for him and it is his duty to pay off the debts.
The House of Lords in the above case held that the company is completely different and distinct from its members, a company is not an agent nor a trustee for its members, managers, or directors. The law sees the company to be a separate, artificial legal person. In this case, the corporate personality, i.e., separate legal entity of the company and its members was strongly established.
In another case, Lee v. Lee’s Air Farming Ltd. (1961) A.C. 12 (P.C.), the facts of the case were that Mr. Lee had a company Lee’s Air Farming Ltd. formed for the purpose of running the business of aerial top dressing. Mr. Lee was the chief pilot, director, held 1 share, and was also a salaried employee of his company as he worked as the chief pilot. Unfortunately, during his work, he died due to an air crash. His wife claimed compensation from the company as Mr. Lee died during the time of his employment. The company opposed the claim on the grounds that Mr. Lee was not a worker because the same person cannot be the employer and the employee at the same time.
The Privy Council in the above case held that Mr. Lee and his company were two distinct persons as per the concept of separate legal entity thus, the claim of Mr. Lee’s wife for compensation is valid. The corporate personality of a company is followed for all the companies whereby the company and its members are considered as two separate persons.
Doctrine of Lifting/Piercing of Corporate Veil —
From the above explanations, we can infer that the law considers a company and its members as two distinct personalities. But there are times when the members of the company misuse the corporate personality. During such misuse, the Court will lift the veil of separate legal entity and will consider the company and the members to be the same person.
Through the doctrine of lifting/piercing of corporate veil, the Court will remove the distinction between the company and its members and will look at the actual person doing the act who is misusing the principle of separate legal entity and is taking shelter behind the company’s name.
This doctrine will be applied by the courts when the members are indulged in any fraudulent activity, dishonest use of the separate legal entity principle, improper conduct, conflict of an act with the public policy, and control of a company by an enemy alien. [Enemy alien means a foreign national (person, company, or government) with which the domestic national is at war.]
In various cases such as Jones v. Lipman, Gilford Motors Co. Ltd. v. Horne, In re, Sir Dinshaw Maneckjee Petit, 1927, Daimler Co, Ltd. v. Continental Tyre and Rubber Co. Ltd., etc., the doctrine of lifting of corporate veil was applied.
The doctrine of alter ego is another doctrine that supports the doctrine of piercing of corporate veil. This doctrine states that a company and its members are alter egos of one another, meaning a person’s secondary personality. The theory of instrumentality is also in favor of the doctrine of piercing of corporate veil, which states that the company is a mere instrument of its members and they use it for their own benefits.
Conclusion —
The principle of separate legal entity is a very important characteristic feature of a company. It is clear from this principle that a company is an artificial person separate from its members. The assets of a company must be used for the benefit of the company and not for the personal benefit of the members. If the corporate personality of a company is misused the law will pierce the corporate veil and hold the members liable for the acts.
