Doctrines of Separate Legal Entity and Corporate Veil

Introduction

In law, a person is responsible for his rights and his liabilities. He/she therefore stands a chance to enjoy the rights and privileges that come with this doctrine or suffer the consequences of his actions once he/she breaches the laws that have been set to act as rules and guidelines to govern a given state or country. Due to this fact, a legal person should follow all the rules and regulations that have been set by the state to ensure that he/she is on the right side of the law.

In law, a legal person refers to an individual or a business entity that assumes limited liability (Miles, 2006). A limited company is the only business that assumes separate entity. It is viewed as an artificial person by the law. Therefore, it has its own rights and liabilities that are independent from those of its owners and managers. Due to this fact, the managers or shareholders cannot be held liable in an event where the company breaches the law or becomes insolvent. This is because the company is viewed as an independent person with its own rights, privileges and liabilities. As such, the doctrine of limited liability applies in such a corporation. Such corporations are protected by the corporate veil. However, there are instances where this corporate veil is pierced by the law to ensure that justice is achieved.

On the other hand, the doctrine of limited liability does not apply on business entities such as sole proprietorship and partnership. In such organizations, the owner or the partners and the business itself are regarded by the law as one entity. Due to this fact, the owners of such business entities shall be held liable if their businesses breach the law or become insolvent.

This essay will therefore focus on the doctrines of separate legal entity and corporate veil and their application in corporation law. It will explore on the application of these doctrines, their exceptions and finally a conclusion shall be arrived at whether individuals are for or against the law.

Separate Legal Entity

To understand the doctrine of separate legal entity, it is essential to have a background information of how the law operates. The law has several rules, procedure and guidelines that help it to be effective and efficient in governing its subjects. In addition, each statute or law has its own doctrines that specify its applicability. The doctrine of legality of a person is one among the many doctrines that are present in law. This specific doctrine is essential for the purpose of this discussion.

According to Ohrenstein and Chambers (2006), a person is one whom the law recognizes as having specific rights, duties and liabilities (24). Due to this fact, courts enforce the rights and liabilities to such persons. For effectiveness, the law classifies persons into two different categories; natural persons and artificial persons (Ohrenstein and Chambers, 2006). Human beings fall under the category of natural persons. They have specific rights and duties. Artificial persons on the other hand are specific personalities that are created by law. In most occasions, they are referred to as corporations. They have their own rights duties and liabilities that are independent from the individuals who formed them (Michael, 1989). Due to this fact, there should always be a distinction between the individual members who formed the corporation and the business entity itself. This is because both parties have their own rights and liabilities. As a result therefore, one cannot enjoy the privileges of the other party or be liable for the actions that accrue from the other party. This is what is referred to as the concept of limited liability.

From the above explanation, it has become clear that a corporation is a separate entity that has its own rights, duties and liabilities before the law. Due to this fact, a corporation can enter into a contract in its own name. It can also sue or be sued in its own name. From the concept of limited liability, it is essential to note that individual debts and business debts are independent from one another. A corporation cannot therefore be held liable for the debts of its directors, members or shareholders. On the other hand, the directors, members or the shareholders cannot be held liable to the debts of a corporation. This is due to the application of the concept of limited liability that supports the doctrine of separate legal entity.

The case of Salmon v Salmon & Co. Ltd 1897 is perhaps the most common case that has been used to explain the concept of separate legal entity and limited liability. Salmon had started off a boots manufacturing company. The initial capital that was required to start off the business was £30, 000. This was divided into 20, 000 ordinary shares of £1 each and 10, 000 debentures. Of the 20,000 ordinary shares, Salmon held 19,994 shares while his wife and five sons each had one share. In addition, Salmon held all the debentures. In the course of its operations, the company became insolvent. The assets of the company were not enough to offset all the creditors. Due to this fact, the unsecured creditors sued Salmon, who was a secured creditor to the company so they could have preference on the debentures. They based their arguments that since Salmon was the director of the company, he should therefore compensate them for their loss. The House of Lords, after a discussion, reached to a conclusion. They stated that the company, Salmon Co. Ltd and the director, Salmon are two different personalities. Therefore, one (Salmon) cannot be held liable to the liabilities of the other party (Salmon Co. Ltd.). This was due to the application of the doctrine of separate legal entity. Due to this fact, Salmon had the right to be paid first since he was a secured creditor (Epps, 2007). This law is still in application up to the present date.

Scholars, from their studies, have identified several reasons why the application of the concept of doctrine of separate legal entity is effective and efficient. According to Epps (2007), the doctrine of separate legal entity has enabled many companies from across the world to accumulate huge sums of capital from their shareholders (13). As a result of the concept of limited liability, shareholders have the confidence of investing their money in companies. This is because, in case the company becomes insolvent, their personal assets shall not be recovered in order to clear the debts of the company. Many people would not have been modest to invest into ventures regardless of the returns they could have earned if the concept of limited liability was not applicable. From the studies that have been conducted, it is evident that limited liability encourages investments (Epps, 2007).

Due to the concept of limited liabilities, it is not necessary for shareholders to hold diversified portfolios. As a result, their rates of return from their investments are relatively lower. This in turn reduces the capital expenditure of corporations. As a result, such companies will earn a higher rate of return as compared to companies that have unlimited liability. Finally, the concept of unlimited liability has eliminated the need of active participation of shareholders in the running and management of entities. If the concept were not applicable, shareholders would always have the fear of being liable to the debts of the entity. Due to this fact, they would try to run or at least control the performance of the organization. In addition, they may be keen on the contracts and deals that the company is submitting itself into. This will lead to increased operational costs and minimal returns.

Corporate Veil

In practice, there is said to be a corporate veil between the directors, members and the corporation itself. This therefore means that there is a distinction between the directors, members and the corporation; the law views them as different personalities. Due to this fact, an individual member or director cannot be held liable for the liabilities of the corporation. On the other hand, the corporation cannot also be held liable to the liabilities of either its members or its directors. The doctrine of corporate veil is just like an extension to the concept of limited liability.

Under normal circumstances, when a creditor discovers that a company is insolvent, he/she will try his best to try to recover his debt from any associate of the company. This includes the directors, members or even shareholders. This may prove to be a difficult and tedious exercise since these individual are protected under law from the liability of their corporation. This was well covered under the rule of Salmon in the case of Salmon v Salmon and Co. Ltd.

However, there are those situations where the exception to this rule applies. Under such circumstances, the directors, members and shareholders may be held liable to the liabilities of the corporations that they are members of. Under such circumstances, a corporation and its members are viewed by the law as one and the same by the law. As a result, the corporate veil can be pierced or be lifted hence liability can be imposed to individual members that make up the company. This may be the directors, board members or the shareholders (Epps, 2007).

However, there are only specific circumstances when the corporate veil can be lifted. If, for instance, a company operate without obtaining a trading certificate, then the directors shall be held liable to any loss that accrues to its creditors. In such circumstances, the directors of the company are expected to indemnify the third whom the company entered into contract with. The directors should compensate the loss or damage that was suffered by third parties as a result of operating their company without following the necessary procedures and guidelines. In other circumstances, a representative may be personally liable if he fails to use the name of the company that he/she represents. The same punishment shall be applied to any disqualified director who continues to operate in the name of a specific company after being dismissed. In addition, the corporate veil shall be raised if the company engages itself in fraudulent or wrongful trading.

With regards to the arguments that have been presented in this paper, Millon (2007) states that it is advisable for courts to respect and abide in accordance to the concept of limited liability. In doing so, the courts would have respected the doctrines of separate legal entity and corporate veil. However, for the concept of limited liability to be applied, the directors, members and shareholders should ensure that the operations of their corporations are conducted in a financially responsible manner (Millon, 2007). As such, the operations of a corporation should be conducted in good faith. At the same time, a corporation should be able to meet the obligations of its creditors in a timely manner. Directors should therefore manage their corporations in a manner that minimizes the occurrence of any risk. However, directors, shareholders and members of a corporation fail to meet these requirements, then it will be advisable for the courts to lift the corporate veils in a bid to indemnify trade creditors.

Conclusion

From the arguments that have been presented in this paper, it is evident that it is essential for the law to differential between a corporation and its members. This ensures that the rights and liabilities of each party are respected. This therefore ensures that the operations of organizations are effective and efficient. However, in an event where a corporation is operating in a manner that is not consistent with the law, then the concept of limited liability should not apply. Such an act should lead to the imposition of the liabilities of a corporation to its directors, members or shareholders. This will be done with the interest of indemnifying third parties from their losses.

References

Epps, O. Company Law: Legal Persons. American Journal of Law, 4 (5), 7-22

Michael J. (1989) Reverse Piercing the Corporate Veil: Should Corporation Owners Have It BothWays? Boston: Princeton Hall

Miles, G. (2006) General principles of Law. New York: Sage

Millon, D. (2007) Piercing the corporate veil, financial Responsibility, and the limits of limited Liability. Emory Law Journal, 56 (5), 1309-1382

Ohrenstein, D. and Chambers, R. (2006) Lifting the Corporate Veil. JBL, 1 (4), 1-15.