The concept of separate legal personality in a company

Keywords: separate legal personality essay, uk and us company law, corporate veil

The concept of ‘separate legal personality’ in U.K. and U.S. Company Law: A Critical Review.

“Did you ever expect a corporation to have a conscience, when it has no soul to be damned, and no body to be kicked?”

–a quote by First Baron Thurlow, Lord Chancellor of England (1731-1806)

The aim and structure of this paper:

This dissertation shall provide a critical review of the concept of ‘separate legal personality’ in U.K. and U.S. Company Law.

The structure of this review shall take the following form:

In the Introductory Chapter, the historical origins and rationale for the introduction of the concept of ‘separate legal personality’, in the U.S. and the U.K., shall be examined and described.

In Chapter 1, we shall examine the theory behind this concept, i.e. the theories which have been offered by academic commentators and eminent members of the judiciary, within each respective jurisdiction, to explain and/or justify the existence of the concept of ‘separate legal personality’ in U.K. and U.S. Company Law.

In Chapter 2, an historical analysis pertaining to the evolution of the above-identified theoretical bases shall be provided. In particular we shall examine how the popularity of each school of thought has varied since 1862.

In Chapter 3, we shall discuss and examine the concept which has become known as ‘the corporate veil’; namely the idea that Directors, officers and shareholders of limited liability companies are not completely invisible to the tentacles of corporate liability; and also the process which has become known as ‘piercing’ or ‘lifting’ the corporate veil (Ottolenghi, 1959); namely that, under certain circumstances, the law will not allow these parties, Directors in particular, to be protected against all personal liabilities. Through extensive examination of the case law and statute, and reference to the learned interpretations of academic commentators, we shall examine under what circumstances the corporate veil may be lifted in this way, i.e. ascertain the actual extent of the liability protection which is personally afforded to the Directors, officers and shareholders of limited liability companies in the U.K. and the U.S.

In Chapter 4, for both the U.K. and the U.S., we shall examine the current position at law regarding the corporate veil and the concept of separate legal personality. In particular we shall examine the most recent case law and statutory amendments, and their underlying rationales, in order to provide answer to the following question, a question which shall form the basis of the concluding Chapter of this dissertation:

Conclusions: ‘In light of the respective current commercial climates in the U.K. and the U.S., are the underlying rationales of the concepts of separate legal personality and the corporate veil still appropriate?’

The Introductory Chapter:

The historical origins and rationale for the introduction of the concept of ‘separate legal personality’, in the U.S. and the U.K:

It is interesting to note that concept of separate personality is to some extent engrained within our modern understanding of what constitutes ‘the corporation’: The Oxford English Dictionary, for example, defines the corporation as, “a body corporate legally authorized to act as a single individual; an artificial person created by royal charter, prescription, or act of the legislature, and having authority to preserve certain rights in perpetual succession.” [OED, available online at ] It is also interesting to note that this definition concedes to the artificiality of this personalized construct; a corporate company after all is merely “a convenient instrument for carrying out business activities…they are entirely amoral and thus lacking any capacity for ethical self-discipline or moral judgment.” [Paine, 2002, p56] The question we are forced therefore to ourselves is at what point in history, and why, did our inherent understanding of what constitutes a company change to incorporate a characteristic which is, self-admittedly, artificial?

The UK perspective:

In 15th Century Britain, the corporation was not yet deemed to possess its own separate legal personality. Evidence of this can be seen from the dictum of Sir Edward Coke in the case of Suttons Hospital (1613): “Corporations cannot commit treason, nor be outlawed nor be excommunicated, for they have no souls.”

In fact it was not until the 19th Century, during the Industrialization of Greater Britain, that the corporation was really given separate legal status. The reason for this is somewhat intuitive but worthy of remark; in a political climate preoccupied with rapid economic growth, the Victorian government realised that entrepreneurs should be encouraged through financial incentive, or otherwise, to start up new business ventures which would form the basis of a prosperous economic future for Greater Britain. One such incentive was to remove the personal risk of liability from the Directors, officers and shareholders of start-up commercial companies; the idea being that prospective entrepreneurs are more willing to engage in medium to high risk business strategies, and corporate diversification, both practices which hold greater promise of financial reward, if they can be guaranteed personal protection from any resulting company debts and liabilities. The introduction of the limited liability company (as standard) did not happen overnight, but rather was brought about by a series of reforms and changes to the way companies are incorporated, which eventually resulted in the enactment of the Companies Act 1862.

Case law prior to the enactment of this legislation was responsible for changing the pre-existing conception of the company ‘share’ and the liability of the company ‘shareholder’. In 1837, for example, in the case of Bligh v. Brent, it was decided that shareholders of incorporated (joint stock) companies did not possess interests in the company’s assets, per se, but rather its profits; thus the share represented not a realty right but a mere personalty.

This case was heavily criticised at the time for its failure to conform with the provisions of the Statute of Mortmain, which categorically stated that shares in a company represent a share of that company’s assets, whether they be land, profits or debts. This criticism was particularly pertinent in regards to those incorporated companies whose business was closely connected to real estate; where a company is asset rich, but profit poor, then the notion of the share as personalty is far less valuable than the conception of the share as realty- it seems unfair to devalue the assets of shareholder’s through retrospectively applied legislation.

In 1855, the Imperial Government enacted the Limited Liability Act 1855. This Act reluctantly permitted those companies with over 25 shareholders to enjoy a limited liability status.

Finally, in 1862, the legislative announced the introduction of the Companies Act 1862 which formally consolidated the position of the law in respect of separate legal personality of UK incorporated (and unincorporated) companies. This Act extended the provisions of the Limited Liability Act 1855 to include all incorporated (joint stock) companies with seven or more shareholders.

The extent of this new legislation was clarified by the House of Lords in the case of

Salomon v Salomon & Co Ltd. The facts of this case were as follows: Salomon, a sole proprietor, was a successful leather boot manufacturer. When his sons were later interested in joining the company he decided to incorporate his business as a Limited Liability Company, with his family members each owning a single share, whilst he became managing director majority shareholder. He then sold the business to the company, part of which was financed by a £10,000 loan from himself. By doing so, he became both principal shareholder and creditor. When the company became insolvent, Mr. Salomon, as a secured creditor was able to recover his £10,000 loan in preference to the company’s unsecured creditors. The liquidator tried to argue that this was fraudulent behaviour and that the debentures were not valid. The initial trial judge ruled in favour of the liquidator by saying that Salomon’s actions were those of principal with the company as agent and therefore he was liable for the company’s debts. On appeal the Court of Appeal upheld the decision on the basis that the privileges of incorporation and limited liability had been abused and described the company as a fiction, a myth and a scheme to take advantage of limited liability.

The House of Lords, however, did not uphold this decision. They criticised the Court of Appeal for suggesting a logical formulation which would have far reaching negative consequences on modern businesses, many of which have shareholders who are essentially ‘disinterested parties’. Lord McNaughton argued that Mr Saloman was perfectly entitled to use this legislation to his commercial advantage, as long as his actions did not contravene any provisions of the Companies Act 1862, either on a literal or purposive interpretation of the statute.

Tomasic and Bottomley, xxxx, p33 have argued that the result of this case was to affirm at law the principle that “a corporation is a distinct person with its own personality separate from and independent of the persons who formed it, who invest money in it, and who direct and manage its operations”.

This interpretation and conclusion is supported both by case law and additional academic commentary: Kerr LJ for example, in the case of MacLaine Watson & Co Ltd v Department of Trade and Industry [1988] 3 WLR 1033 at 1098 argued that the result in this case, namely that a corporation should be considered a separate legal entity in its own right, has proven to be a cornerstone of modern company law. Ford et al (1997) at p101, have argued the same, and add that the implication of this decision is that the rights and duties of a corporation are not the same as the rights and duties of its Directors or member shareholders, the former indemnifying the latter behind what they describe as a veil of incorporation.

Despite the plethora of case law (and subsequent revisions of the Companies Act and the Limited Liability Act) refining and changing this aspect of UK Company Law, the ratio descendi in the Saloman case is still universally considered good law (Tomasic, Jackson, and Woellner, 1992, p98; Gower, 1992, p88; both quoted by Puig, 2000, at 5).

The Scottish Perspective:

N.B. It should be noted that the development of Company Law in Scotland is different to that described above for the U.K. generally. Whilst it is not within the scope of this essay to provide a comprehensive comparative analysis between these different jurisdiction, this researcher shall aim, wherever appropriate, to provide some insight into the unique position of Scottish law regarding the development of the concepts of separate legal personality, limited liability and ‘the corporate veil’.

The first major distinction to note is that in Scotland, Companies are known as Partnerships, Limited Companies therefore as Limited Partnerships.

In 1890, the Scottish Parliament enacted the Partnership Act 1890, s4(2) of which defines the ‘kilted partnership’, i.e. the Scottish Partnership, as ‘a legal person distinct from the partners of whom it is composed’. This separate legal personality was extended to Limited Partnerships by Section 7 of the Limited Partnership Act 1907.

The U.S. Perspective:

N.B. It would be impractical to attempt a comprehensive historical analysis of the developments of the concepts of separate legal personality and limited liability status (of corporate companies), across the entire U.S.A., within this dissertation: there are 52 States of America, each with their own particular Company Laws, each with their own state-specific evolution and development.

Rather, it is the aim of this paper to identify many of the underlying themes which can be seen to have emerged from U.S. Company Law in general. With this constraint and purpose in mind, let us now examine the historical evolution of the concepts of separate legal personality and limited liability in the U.S.:

The first thing to note is that the introduction of these concepts occurred considerably earlier in time than in the UK or Scotland. In fact, limited liability incorporation and legal recognition of the separate legal personality status of the U.S. Corporation occurred can be traced back as far as the beginning of the 17th Century, if not before.

Of course, this was not the case across all States, and in fact, in 1808, the legislative for the State of Massachusetts actually passed a law which upheld the contrary position; namely, that company shareholders would themselves remain liable for the debts of their company. As Roy (1997) p158 (quoting Berle, 1822) notes: “In 1822, Massachusetts laws stated that any member of any manufacturing company was to remain liable in his individual capacity for all debts contracted during his membership of the corporation.”

This regional variation might be said to reflect the very uncertainty of legal opinions on this matter at this time. Some States felt that limited liability status would help to support and encourage commerce, which would be good for the development of the U.S.A. in general, others either felt sceptical about giving shareholders and Directors such latitude for unsupervised high-risk investment, felt that by allowing companies to enjoy such status the potential for fraud and dishonesty would increase, or opposed limited liability because it did not directly benefit the agricultural workers of the U.S.A., who after all, in the words of Thomas Jefferson, were the backbone of America.

The law in Massachusetts, mentioned above, was repealed in 1829. New York made official their position on limited liability in 1848 when she enacted the General Incorporation Statute 1848. Elsewhere, there was still a great deal of uncertainty, and legal inconsistency; in places Statute would outlaw what had become standard business practice, i.e. the exceptions oft outweighed the rule.

By the commencement of the Civil War in 1861, “judges began to develop a doctrine that conferred limited liability on shareholders in the absence of any charter provision to the contrary. Usually, however, charters were not silent. Some required that shareholders be exposed to unlimited liability for debts or legal settlements against a corporation; others required “double liability,” which meant that shareholders’ exposure was limited to twice the amount of their investment.”

Whilst this development might be thought to have indicated a changing tide towards limited liability as standard, and thus an open recognition of the corporation as a separate legal personality, in fact, by the beginning of the 19th Century, there was a widely held consensus in the U.S. that the detriments of limited liability would strongly outweigh any of the benefits of increased commercial incentive for shareholders to invest. As Roy (1997) p161 notes, William Cook, a respected U.S. economist and corporate historian, in his seminal book entitled ‘The Corporation Problem’ (1893), wrote, “There is nothing in the corporate form itself to justify the exaggerated application of limited liability… The pernicious movement has decreased the personal responsibility on which the integrity of democratic institutions depends, and has introduced into both investments and social services a dangerous level of insecurity. Its prevalence in this [19th] century has been due to an overestimation of the importance of national internal development [T]he element of personal responsibility is gradually pushing its way back into the management of corporations so far that limited liability, instead of being an advantage, is often regarded by promoters and investors as a positive detriment.”

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That having been said, the decision in the Saloman case did itself prove influential in the U.S., the result being that by 1985, the case law firmly demonstrated a judicial unwillingness to hold shareholders personally liable for either the debts or tortuous negligence of their investment companies.

Chapter 1:

In this Chapter of the dissertation we shall examine the 5 major theories which have been offered to explain and/or justify the concept of separate legal personality for Companies; namely ‘fiction theory’, ‘real-entity theory’, ‘concession theory’, ‘contractual nexus theory’ and ‘agency theory’.

It should be noted that this Chapter is not concerned with the historical context or development of these respective theories, not with the varying popularity to which legal academics and historian have historically (and currently) subscribed. Rather we are concerned with an analysis of the underlying ‘logical’ foundations of each theory as potential justifications for permitting corporate companies to retain or adopt the status of separate legal personalities.

Fiction Theory of Separate Legal Personality:

The fiction theory of legal personality is often confused with the concession theory which we shall discuss later in the Chapter. Under fiction theory, the corporation is not viewed as an actual person; to attempt to draw such a similarity is abstruse. Rather the corporation is a ‘person’ to the extent that the law afford to it certain properties which may (or may not) be analogous to those rights enjoyed by a sui generis human being.

As Michoud (1899) p8 writes: “For legal science, the notion of person is and should remain a purely juridical notion. The word signifies simply a subject of rights-duties, [sujet de droit] a being capable of having the subjective rights properly belonging to him.”

The question which fiction theory proceeds to ask, and then answer, is whether or not the above named ‘person’ has inherent characteristics which make him (or her) eligible for these rights and duties. Dewey eloquently expresses the complexity of this query: “If one denies that he can find such a common essence he holds that “person” as applied to corporate bodies denotes only a fiction. But if he denies the fictitious character of a corporate entity, then some personality identical in essence, or with respect to “subjectivity,” must be discovered for all right-and-duty-bearing units, from the singular man on one side (including infants, born and unborn, insane, etc.) to the state on the other, together with all kinds of intervening corporate bodies such as “foundations,” “associations” and corporations in the economic sense.” (Dewey, 1926, p 659)

In essence the fiction theorist uses a form of two step logic to effectively reverse the burden of proof requirement; i.e. if one assumes that a person is entitled to a certain set of rights and is simultaneously constrained by a set of duties, and one also chooses to argue that it is not a fiction to describe a corporation as a person, then one must be able to identify the feature of the company which inherently attached to that commercial association the same rights and duties to which one has agreed all personified units are entitled. As Dewey, 1926, p659 notes, “Clearly, this is not an easy task; it is so difficult of accomplishment that it accounts in the main for the voluminous continental literature concerning juridical personality, or as French writers generally say, “Les Personnes Morales.””

The fiction theorist thus relies upon the difficulty of providing such an answer on which to base his or her conclusion that the description of the company as a person is merely a fiction, and thus only a ‘person’ to the extent that the law confers on that corporate body rights and duties which are similar to those enjoyed by a natural person.

In conclusion the fiction theorist’s conception of the corporation is, as Chief Justice Marshall opined, in the Dartmouth College Case, “as an artificial being, invisible, intangible, and existing only in contemplation of law.”

The Concession Theory of Separate Legal Personality:

The Concession Theory of separate legal personality is often confused with the fiction theory, although if carefully understood, is substantially different. In short, to borrow some of the wording from Chief Justice Marshall, above, concession theory relies upon the fact that the corporation ‘exists only in contemplation of the law’.

The concession theorist argues that since the corporation, as a separate legal entity, is merely a construction of the law, a product of its provisions, then it is by definition, an artificial construct and unlikely to be real. As Michael Phillips (1994) p 1064 writes, “If corporations are creatures of state law and nothing else, [then] they almost certainly must be artificial, invisible, intangible, and fictional.”

The most all embracing, self-explanatory and (thus) oft-cited description of concession theory which can be found in the academic literature is that provided by Freund in his seminal work entitled Standards of American Legislation (1917) 39: “In its various forms of ecclesiastical bodies and foundations, gilds, municipalities, trading companies, or business organizations, the corporation has always presented the same problem of how to check the tendency of group action to undermine the liberty of the individual or to rival the political power of the state. The somewhat vague theory of the later Middle Ages that communal organization not sanctioned by prescription or royal license was illegal was at least from the fifteenth century on supplemented by the technical doctrine, developed under canonist influences, that there is no capacity to act as a body corporate without positive authorization. To grant this authority has remained in England an attribute of the royal prerogative… It is hardly possible to overestimate the theory that corporate existence depends on positive sanction as a factor in public and legislative policy. It is natural that the charter or incorporation law should be made the vehicle of restraints or regulations which might not be readily imposed upon natural persons acting on their own initiative, and the course of legislative history bears this out.”

Thus, it immediately becomes clear that in fact concession theory, rather than being a philosophical justification (or counter-justification) for the imposition of the concept of separate legal personality on the Commercial Corporation or enterprise, is instead a mechanism by which we can understand the corporation as nothing more or less than the product of those laws, Charters and rules which have sought to create it. As Dewey (1926) notes, the concession theorist is not concerned with the question of whether or not the corporation is a ‘real’ entity; such a pursuit is wholly abstruse. The corporation is what the law says the corporation is, and focus must therefore be on the question of whether the law is not correct in giving it ‘separate legal personality’ but whether the extent of the rights and duties conferred upon it are appropriate within the current business climate. As Gilligan (2001) p36 notes, because the corporation as a separate legal personality has been created by the State, any government intervention, such as the imposition of new Regulations and or governing legislation is fully justified.

The Real Entity Theory of Separate Legal Personality:

The Real Entity Theory can be instantly distinguished from the Fiction Theory in that the former perceives the corporation to be a ‘real’ or ‘natural’ entity in itself, whereas, fiction theory, as we have seen from our earlier discussion, sees the corporation as wholly artificial.

Real Entity Theory can also be distinguished from Concession Theory in that the former, whilst accepting that the law does purport to create the corporation in its personified form, argues that in fact the law only does so because there is something inherently ‘real’ about this conception of the corporate body. As Machen (1910) p257 writes, “That which is artificial is real, and not imaginary; an artificial lake is not an imaginary lake”.

The real entity theory argues that the corporation possesses inherent characteristics which are above and beyond those possessed by its individual human members. One might draw similarities to the thespian who swears that the reason that he so much enjoys taking part in theatrical productions is that he is able to be part of something bigger than himself. This anecdotal evidence is highly suggestive of the fact that a group of human beings, when incorporated, i.e. working together to achieve mutually beneficial goals, actually form a shared organism; thus a natural entity is created, admittedly one which could not exist without the contributions from its individual members, but a natural entity all the same. A more concrete example of this is provided by the legendary Maitland: In describing the ‘German Fellowship’ Maitland writes: “[It] is no fiction, no symbol, no piece of the State’s machinery, no collective name for individuals, but a living organism and a real person, with a body and members and a will of its own. Itself can will, itself can act; it wills and acts by the men who are its organs as a man wills and acts by brain, mouth and hand. It is not a fictitious person; . . . it is a group-person, and its will is a group-will.”

Under this organism conception of the corporation it follows that, if its assumptions are correct, the corporation itself has moral rights and duties distinct from that which is merely prescribed by law. This is not a view which has been made explicit by the commentators in this area, but there are certainly those who have hinted to this end, e.g. Deiser (1909).

It should be noted that not all real entity theorists view the corporation as an ‘organism’ in the biological or natural sense of the word. Some concession theorists rather argue that the corporation is a system or machine which operates as a direct result of the interactions of its members. Proponents of this materialistic view of real entity theory include authors such as Werhane (1985), and possibly Machen (1911), although he refuses to comment upon the precise nature of the corporate entity.

The Contractual Nexus Theory of Separate Legal Personality:

The Contractual Nexus Theory of the Corporation does not view the corporation as a separate legal personality, per se, but rather views it as a collection of contractual relationships between the company stakeholders, i.e. the managers, Directors, share holders, employees, customers, suppliers, sub-contractors etc.

This theory is the first that really attempts to explain why shareholders don’t own the assets of a commercial corporation: the shareholder owns a share which itself is a contract with the company, a contract under which they agree to provide their capital investment to the firm in return for receiving dividends, i.e. their share of the companies net profits.

Despite the clear artificiality of imposing contractual relationships into arrangements which often do not fit squarely within our normal notion of what constitutes a contractual relationship, this theory, or model of the firm has a certain tidiness which the other theories so far discussed to not provide. The fact is however that this theory fails to differentiate between fiduciary and contractual obligations- Directors owe their shareholders a fiduciary duty, namely to act in ways which will yield net profit revenue, and this duty cannot be accounted for by contract alone. As Lewis Kornhauser (1989) p1451 notes, “Complications arise in corporate transactions because the relevant ‘agreement’ is generally unwritten, frequently ambiguous or contradictory and often not an agreement at all. Rather the nexus of contracts approach constructs an agreement out of the interests of the relevant parties.”

On a fundamental level this theory also breaks down when one considers that often the Directors of a company will also be the major shareholders of that company: it is a long standing and universally accepted principle of contract law that one cannot contract with oneself!

This theory also poses problems in relation to organizational structure; for example, under this theory, managers are directly responsible for their failings, or more correctly stated, ‘breaches of implied contractual duty’, but in return, they are not entitled to any of the real benefits of the firm. This theory has been extensively criticised for its failure to deal with the inherent corporate inefficiency caused by the divergence of interest between, in particular the managers and the owners of a corporate organization: “Managers bear the entire cost of failing to pursue their own goals, but capture only a fraction of the benefits.” McColgan, 2001, p4.

The Agency Theory of Separate Legal Personality:

The Agency Theory of separate legal personality should be understood as being inextricably linked to the contractual-nexus model discussed above.

Those inherent flaws identified in the contractual nexus model which pertain to the divergence of interest between the Directors and managers of a commercial corporation create a need for the corporation to effectively manage their members appropriately for this inherent inefficiency. A natural result of this inefficiency is the need for increased agency costs, i.e. ‘the sum of monitoring costs, bonding costs, and residual loss’ which are required to audit manager performance (Jensen and Meckling, 1976).

Let us now examine agency theory from the point of view of the shareholders:

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The Directors of a company, in meeting their agency duties (and therefore, by necessary implication, costs), are effectively responsible for reducing the value of the dividends which are payable to the shareholders, who are owed these dividends by virtue of their contracts with the Company. Effectively therefore, the shareholders are paying the company a premium, i.e. an increased amount of capital investment, in order to meet these agency costs of monitoring etc. This very fact means that the risk of a shareholder investing in the company will increase. Some commentators have thus argued that more appropriate than an agency model would be a bonding model, where the Directors of a company are bonded to creditors in the event of liquidation or bankruptcy. This would reduce both the risk and the cost of shareholder investment, but would simultaneously render the Directors liable personally to settle the company debts with its creditors upon liquidation.

On the other hand, there is also an argument that this alternative bonding model would only serve to make company Directors more cautious when making investment decisions; this might have the undesirable effect of reducing the profitability of the company, thus reducing the amounts of dividends payable to the shareholders anyway.

In conclusion, Agency Theory is not strictly speaking a theory which purports to justify or explain why a commercial corporation should enjoy a separate legal personality. Rather it is a methodology to deal with the inherent problems which are raised by the Contractual-Nexus Theory, in particular the tendency for divergence of interests between the Directors and managers of large corporations and limited companies.

Chapter 2:

Having analysed the logical bases of the five main theories of limited liability and companies’ separate legal personalities, in this Chapter we shall examine the chronological development of these theories and also how their respective popularities with legal academics and historians have varied over the past century.

N.B. It should be noted that the five theories discussed in the previous Chapter are theories which have been promoted and supported across the globe. Ideally, in the Chapter, we would attempt to trace the popularity of each of these theories in both the U.K. (including Scotland) and the U.S. However, such a comprehensive historical analysis is beyond the practical scope of this dissertation. Instead, this researcher shall attempt to map the respective evolution of these theories by way of general global analysis, only referring to jurisdiction-specific trends where absolutely necessary.

The very reason that so many theories have been proposed to try to explain, justify and model the corporation is a complex one. As Dewey (1926) p663 to 664 writes, “to answer this question is to engage in a survey of the conflict of church and empire in the middle ages; the conflict of rising national states with the medieval Roman empire; the struggle between dynastic and popular representative forms of government; the conflict between feudal institutions, ecclesiastic and agrarian, and the economic needs produced by the industrial revolution and the development of national territorial states; the conflict of the “proletariat” with the employing and capitalist class; the struggle between nationalism and internationalism, or trans-national relations, to mention only a few outstanding movements.”

Arguably, the Fiction Theory of the modern commercial corporation is a direct descendant of the same fiction theory which for so many years has formed the basis for the organizational structure of the Roman Catholic Church. As Gierke (Translated in 1950) p 97 notes, “Pope Innocent IV was the father of the dogma of the purely fictitious and intellectual character of juridical persons which still rules.”

Upon this logical basis it is quite clear to see why, during the periods of great economic national and international growth which were seen in the U.S. and the U.K. during the latter half of the twentieth century, there was such growing support for the conception of the company as a real and independent social and moral entity: As Dewey (1926) p 663/4 (footnote 11) so eloquently writes, “One potent recent motive for the insistence upon the real “personality” of social groups, or corporate bodies, independent of the state, is opposition to the claim that the state is the sole or even supreme Person. The latter notion reflects the increase of importance of the national territorial state. Opposition from the side we are alluding to, is due to the fact that the doctrine of the ultimate personality of these states finds fitting expression in wars. Moreover, these wars confer upon the states too unrestricted power over their citizens, and also unfavorably affect the complex economic interdependences wrought by modern methods of industry and commerce.”

In many respects therefore the increasing popularity which could also be seen in the concession theory of separate legal personality can be attributed as a natural reaction to this growing focus on real entity theory. Concession theory after all, as a movement, sought to argue that Government’s right to intervene in commercial life, through imposition of corporate regulation, was legitimized by the very processes which led companies to enjoy separate legal status in the first place. This researcher would like to raise his own personal observation at this point: the argument of concession theory, namely that Governments are justified to regulate the modern corporation because the Government was responsible for the creation of the corporate entity in the first place, does not seem such a strong argument when one compares this relationship to that which currently exists between the UK Parliament and the European Parliament of the European Union: Whilst it is certainly true that the legitimacy of European sovereignty was initially created by way of UK Government dispensation, the relationship has moved well beyond this preliminary stage; it is now the case that European Parliament is sovereign, and as such the UK Government are forced to engage in an all or nothing approach to European obedience. Thus, the argument that “I created you, thus I control you” is not necessarily a valid one when it comes to Governmental relationships.

Regarding the contractual-nexus theory, and its popularity in the modern business climate: The 1970’s and 1980’s in the UK and the US saw a resurgence of popularity towards this theory of the corporation as a separate legal entity (Phillips, 1994, p1064; Jensen and Meckling, 1976, generally).

This remained the most popular conceptualization of the corporation until the early 1990’s, when a series of public scandals started to highlight the deficiencies in the Agency model which, as discussed in the previous Chapter, was closely intertwined with the contractual nexus theory of the corporation.

framework until the early 1990’s where a series of public corporate scandals in the UK created a demand for a new more accountable form of corporate governance.

These events gave credence to the arguments against the contractual-nexus theory and its Agency counterpart; namely that these models were incapable of preventing an inherent divergence of interest between the company Directors, managers and the Company as a separate legal entity.

The result is a theory which this researcher deliberately chose not to discuss in the preceding Chapter, namely the social entity theory of the corporation.

This theory of the corporation is similar to the real entity theory in that it conceptualises the corporation as a real and separate legal entity with its own set of rights and moral duties. This theory assumes that the corporation actually serves a positive purpose in the current UK and US societies- the social entity theorist no longer views the formation of the corporation as a mere result of failing (or under-achieving) capital markets. Building upon the psychological doctrines of social influence theory (Tedeschi and Felson, 1994), social entity theory focuses on the need for a team culture of shared rights and responsibilities between the members of the modern commercial corporation; a culture of horizontal stakeholder involvement and a culture of shared responsibility and reward. In conclusion to this Chapter: it is Social Entity Theory which holds the firm position today in the UK (including Scotland) and the US, as the most popular (and socially responsible) conceptualization of the 21st Century commercial corporation.

Chapter 3:

In this Chapter, we shall examine the concept of the ‘corporate veil’, in particular the current position of the law in the U.K. and the U.S. in relation to the ‘lifting’ or ‘piercing’ of this veil, in light of the new culture of social entity theory, and shared rights and responsibility between all members of the modern corporation which has ensued.

In the introductory Chapter of this dissertation we examined the historical origins of limited liability in the U.K., Scotland and the U.S. We saw how the U.K. and Scotland were much quicker to adopt limited liability than the U.S. who still does not enjoy universal limited liability as standard in every one of its 52 States. In light of this discussion, little needs to be said about what is meant by ‘the corporate veil’: the ‘corporate veil’ is the natural result of granting a company limited liability status. It essentially means that the member of the company will not be personally liable for the debts of the Company upon insolvency.

More interesting, in light of the modern corporate climate of Director accountability, is a comparative examination of the limitations on this personal liability protection between these respective jurisdictions, i.e. under what conditions is the law prepared to lift the corporate veil and hold company Directors (and other members) personally liable for the financial consequences of their misfeasance, fraudulent behaviour, or otherwise? It is this question which will form the primary subject-matter of this Chapter of the dissertation.

‘Lifting or piercing the Corporate Veil’ in the UK:

The distinction between ‘piercing’ and ‘lifting’ the corporate veil has been defined by Lord Justice Staughton in the case of Atlas Maritime Co SA v Avalon Maritime Ltd [1991] 4 All ER 769: “To pierce the corporate veil is an expression that I would reserve for treating the rights or liabilities or activities of a company as the rights or liabilities or activities of its members. To lift the corporate veil or look behind it, on the other hand, should mean to have regard to the shareholding in a company for some legal purpose.”

Examples of where the Courts have deemed it appropriate to pierce the corporate veil include where a Company officer has been found guilty of breaching one of the provisions contained in s213-215 of the Insolvency Act 1986 pertaining to wrongful and/or fraudulent trading.

For example, s213 of this Act states: “(1) If in the course of the winding up of a company it appears that any business of the company has been carried on with intent to defraud creditors of the company or creditors of any other person, or for any fraudulent purpose, the following has effect (2) The court, on the application of the liquidator may declare that any persons who were knowingly parties to the carrying on of the business in the manner above-mentioned are to be liable to make such contributions (if any) to the company’s assets as the court thinks proper.” Therefore, if a Company Director, on knowing that the company is soon to enter receivership, decides to engage in fraudulent activity to earn him/herself some personal financial gain, then the Court is empowered to pierce the Corporate veil and hold that Director liable for the Company’s resulting debts.

It might be wondered whether this form of practice is really best described as ‘piercing the corporate veil’; after all, in such cases the Director has actually broken the law, and as such has put himself into a position where he is no longer standing behind this limited liability protection.

Returning to examine the circumstances in which the UK Courts are prepared to lift the corporate veil: There is a substantial body of UK case law, spanning across the entire twentieth century, in which this position of the judiciary in regards to lifting the veil has been established, modified and consolidated. Let us now examine a selection of these cases:

In Adams v Cape Industries plc [1990] Ch 433, Slade LJ rejected the argument of the counsel for the claimant that the corporate veil should be lifted wherever to do so it in the interests of justice: “save in cases which turn upon the wording of particular statutes or contracts, the court is not free to disregard the principle of Salomon merely because it considers justice so requires. Our law, for better or worse, recognises the creation of subsidiary companies, which though in one sense the creatures of their parent companies, will nevertheless under general law fall to be treated as separate legal entities.” This demonstrates that the judiciary is loath to lift the veil unless a Company officer has breached a statutory provision or a contract, in which case, as argued above, the Court does not really have to lift the veil at all for the Officer, by engaging in illegal activity (whether that be breach of civil or criminal law) has placed him or herself in front of the corporate veil. This principle was confirmed by the House in the case of Dimbleby & Sons Ltd v NUJ [1984] 1 WLR 427, in which it was held that there is a presumption that legislation should not be interpreted as requiring the veil to be lifted of pierced.

Let us now therefore turn to examine briefly which legal provisions, if breached, or circumstances, if demonstrated, might compel a Court to lift the corporate veil:

One such legal provision is s24 of the Companies Act 1985. Under this section, where the number of Company members falls below two for a six month continuous period, then the one remaining Director/Officer will be responsible for all company debts which have been contracted after this period has expired.

Likewise, under s117(8) of the 1985 Act, where a Company comprising of one Member engages in commercial trade, having failed to obtain a trading certificate, then that member will be jointly and severally liable for any debts arising from his failure to meet his obligations within 21 days of being requested to do so.

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Under s349 of the Companies Act 1985, if a company officer writes a cheque, an order or a bill of exchange without the name of the Company being stated on that document, then that person will be personally liable if the Company then decides to dishonour any such agreement. In many respects this is a simple application of contract law principles; if the company name was not on the document, but rather only the name of the person responsible for executing the transaction, then this document represents a contract between the individual and the supplier, for example, rather than between the Company and that third party. The Courts have demonstrated their unwavering commitment to enforcing this provision in the case of Durham Fancy Goods v Michael Jackson (Fancy Goods) [1968] 2 QB 839.

The Courts will also pierce the veil when a Company member has breached one of the provisions contained in s213-217 of the Insolvency Act 1986; I have provided an example of this earlier, and thus these provisions do not require further explanation within this Chapter of this dissertation.

Finally, the Courts will pierce or lift the veil where a Director, who is currently the subject of a disqualification order, fails to comply with its terms and engages in commercial management of a Limited Company. In such circumstances the Court will hold that person to be in breach of s15 of the Company Directors Disqualification Act 1986, and will hold that Director personally liable for all of his present Company’s debts.

Regarding the circumstances which, if demonstrated, will compel the Court to lift or pierce the corporate veil:

In the case of Gilford Motor Co v Horne [1933] Ch 935, the Court held that where it becomes clear that a Company has only been set-up in order to evade a legal obligation, or to allow an individual to acquire rights or privileges which would otherwise be unavailable to him, then they may be prepared to lift the corporate veil and hold that person liable.

Likewise, where it becomes clear that one Company is merely carrying on business as the agent of another, then the Court is prepared to regard the two companies as one, thus effectively removing the corporate veil. This was decided in the case of Smith, Stone & Knight v Birmingham Corporation [1939] 4 All ER 116, although the extent of this authority must be questioned in light of the decision in the case of Adams v Cape Industries plc [1990] Ch 433, which as we have noted above, held that the Court will be unwilling to lift the veil unless there has been an actual breach of the law. Under the new Companies Act 2006, it may well be against the law to form such agency relationships with subsidiary companies, although case law will be needed to define the scope of this recently introduced Act and confirm this conclusion.

Finally, it should be noted that in the case of Creasey v. Breachwood Motors Ltd (1992) BCC 638 the Court did imply that where it is in the interests of justice to do so, the Court may be prepared to lift or pierce the corporate veil even where not actual legal provision has been contravened. But again, when one considers the case of Adams v Cape Industries plc [1990] Ch 433, it is difficult to be clear as to what degree of public interest would need to be reached before the Court is prepared to do this.

‘Lifting or piercing the Corporate Veil’ in Scotland:

It would appear that the same principles as discussed above are also applicable to the jurisdiction of Scotland (Garcia-Prieto and Guild, 2002), with no exceptions.

‘Lifting or piercing the Corporate Veil’ in the U.S.A.:

N.B. It would be impractical to attempt a comprehensive analysis of the developments of the concept of lifting or piercing the corporate veil across the entire U.S.A., within this dissertation: there are 52 States of America, each with their own particular Company Laws, each with their own state-specific evolution and development.

Rather, below will be provided some general observations about the law in relation to lifting the corporate veil of those companies which are registered as limited liability.

In the U.S.A. the law pertaining to when a Court will be willing to lift the corporate veil of an otherwise limited liability corporation is governed by the principle known as ‘totality of circumstances’. Essentially, there are three main theories which the Courts in the U.S. may rely upon; namely, ‘unity of interest and ownership’ (which is comparable to breach of s117(8) and/or s24 of the Companies Act 1985 in the UK); ‘wrongful conduct’ (comparable to breach of s213-217 of the Insolvency Act 1986 in the UK) and; ‘proximate cause’ (which is comparable to the case law settled in relation to Agency status between subsidiary companies, as per the UK rulings in Adams v Cape Industries plc [1990] Ch 433 and Smith, Stone & Knight v Birmingham Corporation [1939] 4 All ER 116).

If a plaintiff can satisfy the court that one of these three prongs have been breached, then the Court will be able to lift the veil and hold those officers who where responsible for the breach liable for any resulting debts.

Chapter 4:

In the introduction of this dissertation it was stated that in Chapter four we would “examine the current position at law regarding the corporate veil and the concept of separate legal personality,” including particular focus on the most recent developments in this area.

In fact, in light of the comprehensive discussion in Chapter 3, it will be unnecessary to re-examine to current position of the law in regards to the corporate veil, which means that we can focus the attention of this final Chapter on the most recent developments which have occurred, or are currently in the process of occurring.

The only really substantial development of the law on the horizon is how it relates to the relatively recently introduced Limited Liability Partnership company structure:

The LLP was introduced in the US in the 1990’s, and the relevant law governing the limited liability status of this new company structure is (where applicable, i.e. not in those States which have opted out of this legislation) Section 306(c) of the UPA, which states, “An obligation of a partnership incurred while the partnership is a limited liability partnership, whether arising in contract, tort, or otherwise, is solely the obligation of the partnership. A partner is not personally liable, directly or indirectly, by way of contribution or otherwise, for such an obligation solely by reason of being or so acting as a partner.”

Thus, despite the fact that the U.S. LLP is most definitely a partnership structure rather than being incorporated, per se, there is legislation which affords a form of limited liability status to this company structure. As of yet it is unclear how the law pertaining to lifting to Corporate veil will operate in respect of the LLP, but presumably the same three pronged “totality of circumstance” approach will be applied wherever it is appropriate to do so, in light of the differing organizational structure of an LLP compared to an Incorporated Company.

The UK LLP was introduced in 2001, and unlike the U.S. LLP, the U.K. LLP is not a partnership, but rather is a form of limited liability incorporation. The law which governs and regulated the U.K. LLP is the Limited Liability Partnership Act 2000.

Regarding the corporate veil, in light of the fact that the Partnership as a whole does not have to pay tax, but rather each individual partner paying tax on their own earnings, it is unlikely that many of the problems with fraud which have been discussed throughout this essay in relation to the standard Limited Company will prove pertinent.

Regarding non-tax-based reasons for lifting the veil: just like the Limited Company, the U.K. LLP Partners have a shared responsibility for liability, i.e. no one partner will be liable for all the debts of the partnership. Rather than being governed by the Companies Act 1985 (as amended in 2006), the regulations governing when one Partner may be made liable for all of the Partner’s debts are contained within the LLP Act 2000, the contents of which are beyond the scope of this paper, the case law pertaining to which is still in the infancy of its development.

Conclusions: ‘In light of the respective current commercial climates in the U.K. and the U.S., are the underlying rationales of the concepts of separate legal personality and the corporate veil still appropriate?’

In conclusion, I would argue that limited liability and the protection afforded by the corporate veil is a good way of encouraging commercial enterprise to commence and prosper. However, I would also argue that the law should be more willing to lift the corporate veil where a Company has clearly used its Company status to circumvent laws which would otherwise apply if it was, for example, a Company made up of a small number of owner-shareholders. I do not feel that the veil should only be lifted where there is an actual breach of the law. In the UK this line of thinking seems to be prevailing in the Courts; for example the case of Creasey v. Breachwood Motors Ltd (1992) BCC 638 seems to have undermined the former rigid position which was confirmed in the earlier case of Adams v Cape Industries plc [1990] Ch 433.

In the U.S. I would argue that the Government should try to aim for national consistency; whilst the majority of States now permit limited liability status as standard, unless this is standardised across the entire U.S.A. regional disparity of commercial investment will cause business to relocate when their time could be better spend establishing themselves in their respective markets and generating capital revenue.

The outlook for the future looks optimistic in light of the new commercial climate of shared responsibility, which is based upon the doctrines of social entity theory- in the future many of the laws pertaining to when the corporate veil can be lifted will prove obsolete in light of the UK’s unique LLP partnership structure and its supporting regulator framework provided by the LLP Act 2000. Japan have already decided to copy this model and I would advise the U.S.A. to do the same; only through transparency will the 21st Century Corporation be able to develop a symbiotic relationship with the law and Government regulation.

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