LAWS4001 Lecture Notes - Lecture 2: Fiduciary, Trading While Insolvent, Battle Of Milne Bay
Week 2 – The corporate personality
The separate legal entity doctrine
The most fundamental principles of corporate law is that a corporation is regarded as a
separate legal entity from the people who set it up, invest in it, or run it (founders, members
and directors)
Once registered, it is taken to exist as its own legal person who can sue and be sued ‘in its
corporate name and style), enter into contracts in its own name, employ staff, borrow money,
own property and engage in other legal acts a natural person can
Companies act through people, but the legal obligations that arise from such actions are
usually those of the company and do not attach to the individuals
Perpetual succession
Salamon v Salamon
Same benefits for small (one-person companies) and large companies
Acknowledged a company is ‘an artificial creation of the Legislature’
The company is at law a different person altogether from subscribers to the memorandum
and, though it may be that after incorporation the business is precisely the same as it was
before, the same persons as managers, and the same hands receive the profits, the company is
not in law the agent of the subscribers or trustee for them’
The effect of the decision was that any debts owed by the company to the secured creditors
(including Salomon) had to be paid first, once this was done, due to the shortage, none of the
unsecured creditors were paid on the company’s winding up
Individuals could legitimately minimize their personal risk using the corporate form
s 156 Corporations Act: provides that a member need not contribute to the company more
than the amount (if any) unpaid on the shares that they own (default rule)
Same as limited by guarantee: the members is limited to the amount they promise to
contribute via a guarantee to the capital of the company (s 517)
Policy: argued that the challenges created for creditors through the effect of limited liability
are less than the difficulties that would be created for shareholders is there was unlimited
liability
The default rules save firms the cost of negotiating and inserting terms into each of the
contracts they form – corporate law rules aim to achieve a balance between the objective of
shareholder wealth maximization and the protection of those who may be adversely affected
by the activities of the corporation
However, risk is ‘externalized’ to creditors who then have recourse to the company’s assets
for payments of any debts
Seek security from personal guarantees or major shareholders or mortgages over company
property (only for financiers and other large creditors)
In effect, the decision shifted the risk of business failure from shareholders to creditors.
Lee v Lee’s Air Farming Ltd
The Privy Council upheld the principle that a company is a separate entity from its owners and
that those same owners can also be company employees. It followed that the wife was entitled
to the insurance as a widow of an employee
Macaura’s Case
Macaura had earlier insured the timber against loss by fire in his own name. He had not
transferred the insurance policy to the company.
When Macaura made a claim his insurers refused to pay arguing that he as an individual had
no insurable interest in the timber. The House of Lords agreed that the insurers were not liable
and that it was only Macaura’s company as owner of the timber which had the necessary
insurable interest. Shareholders, in particular Mr Macaura himself, did not have a legal or
actual interest in their company’s property
Macleod v The Queen (2003)
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The High Court held that a person who was the only active director and sole shareholder of a
company could be convicted under s 173 of the Crimes Act 1900 (NSW) for fraudulently
taking or applying property owned by the company for his own use)
Exceptions
‘Pierce the corporate veil’ only when there was evidence a corporate structure had been set up
to perpetuate fraud or to avoid an existing legal obligation
Although, just because a person chooses to use a corporation structure to limit their liability
for the debts of the business, or sets up a limited capital (i.e. $1 business), this is not fraud or a
sham
Judges reluctant to depart from the separate legal entity doctrine
a. Evasions of legal obligations
Cases where a company is established to avoid an existing legal obligation, or to carry on an
illegal activity, the courts are willing to disregard the separate status
Gilford Motor Co Ltd v Horne
The company had been set up for the sole purpose of avoiding the restraint of trade clause
Held that both Horne and the company were subject to its terms and an injunction was issued
against both defendants
Prest v Petrodel Resources Ltd
Divorce proceedings whereby question of where the properties could be transferred into the
wife’s name even though they were property of the company (in which the husband owned
and controlled)
Unanimous decision, Supreme Court allowed the wife’s appeal
Prest had contributed money towards the purchase of the properties, therefore, they were held
by the company for him on resulting trust
However, not necessary to pierce the corporate veil, referred to the ‘concealment principle’ to
look behind the veil to discover facts to make decision
Piercing the corporate veil means disregarding the separate personality of the company
There is no set principle on when the court pierces the corporate veil
Lord Sumption:
At CL the corporate veil should only be pierced when no other legal remedy is available and
then only when the company used the company to avoid a legal obligation
Fraud
When the corporate structure is used to perpetuate a fraud or conceal a fraudulent operation
Re Darby
The company had been the ‘promoter’ of the prospectus capital raising and was liable for the
false statements argued
The court was willing to look behind the spate legal nature and impose liability for fraud on
the profit keepers Darby and Gyde, who it considered were the true promoters of the scheme
Agency
The mere fact that a particular shareholder owns most of the shares in a company does not
create an agency relationship
For an implied agency relationship to exist, the facts must show that the principal (usually a
controlling shareholder) has appointed the company to act on its behalf
It must be clear that the company is entering into contracts and incurring legal obligations on
behalf of the principal and not in its own right
Smith, Stone & Knight v Birmingham Co
1. Were the profits of the subsidiary treated as the profits of the parent company?
2. Were the persons conducting the business appointed by the parent company?
3. Was the parent company the head and brain of the trading venture?
4. Did the parent company decide what should be done in the venture and how capital should be
allocated?
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Document Summary
The most fundamental principles of corporate law is that a corporation is regarded as a separate legal entity from the people who set it up, invest in it, or run it (founders, members and directors) Companies act through people, but the legal obligations that arise from such actions are usually those of the company and do not attach to the individuals. Same benefits for small (one-person companies) and large companies. Acknowledged a company is an artificial creation of the legislature". Same as limited by guarantee: the members is limited to the amount they promise to contribute via a guarantee to the capital of the company (s 517) Policy: argued that the challenges created for creditors through the effect of limited liability are less than the difficulties that would be created for shareholders is there was unlimited liability. However, risk is externalized" to creditors who then have recourse to the company"s assets for payments of any debts.
