Separate Legal Entity of a company

3.1 What is Separate Legal Entity?

Separate legal entity means that is a different legal existence to individual members or
stockholder who as natural person of company. A company may sue and be sue in its own
name and holds property separately to its shareholders, directors and officers. They do not
own the assets of the company and personally liable for its debt and obligation. In many
aspect, company are treated as artificial person under the law. As an artificial person, the
company is subject to many of the same rights and obligations under the law as a natural
person.
The legal recognition given to the company is provided by s.16 (5) of the Companies Act,
1965. It says:
On and from the date of incorporation specified in the certificate of incorporation the
subscribers to the memorandum together with such other persons as from time to time
become members of the company shall be a body corporate by the name set out in the
memorandum.
Apart from recognizing the company as a legal entity, s.16 (5) states the effect of
incorporation are:
shall be a body corporatecapable forthwith of exercising all the functions of an
incorporated body and of suing and being sued and having perpetual succession and a
common seal with power to hold land but with such liability on the part of the members to
contribute to the assets of the company in the event of its being wound up

Thus you can see the effect of incorporation as follows:

- A body corporate comes into existence capable of exercising all the functions of and
- incorporated company;
- it has the ability to sue and be sued;
- it enjoys perpetual succession;
- it has the power to hold property; and
- The liability of the members depend on the type of company
A Body Corporate

A body corporate is a legal person that is created and given recognition by the law. This legal
person is actually a legal fiction. It is an artificial legal person unlike human individuals who
are known as natural persons. According to s.4 (1) a corporation is anybody corporate
wherever formed and includes any foreign company.

A company is a type of corporation that is recognized by the law as having powers and
liabilities like an individual. The courts first recognized the company as an individual having
a separate legal personality in the case of:

Salomon v A. Salomon & Co. Ltd. (1897) AC 22

Salomon was a boot and shoe manufacturer. He ran his business as a sole trader. In 1892
Salomon formed a limited liability company. He gave his wife and children one share each in
the company. He then sold his shoe and boot business to the company for f39, 000. In
consideration for the business, the company paid him partly in cash, partly in 20, 000 f1
shares, and partly in f10, 000 debentures issued by the company. By being a debenture holder,
Salomon becomes a secured creditor of the company.

Salomon continued to run the business as one-man company. The business did not do well
and after some time became insolvent. What was left of the assets of the company were not
enough to pay off the creditors. It was mostly used to pay off the debenture held by Salomon.
The other creditors tried to claim that Salomon had no right to the remaining assets as the sale
of this business to the company was a sham, and that his wife and children were merely his
nominees, and that Salomon and the company were in fact one and the same.

The House of Lords held that the incorporation process made Salomon and his company two
separate persons. Even if the business were the same as before, and it was still managed by
Salomon himself, the company was not an agent or trustee for the members. Although
Salomon beneficially owned all the issued shares of the company, the court also recognized
him as a separate person who can be a secured creditor with enforceable rights against the
company.

The principle establishing the separate legal personality of the company from the members
was applied in the case of:

Lee v Lees Air Farming (1961) AC 12

Lee formed Lees Air Farming Ltd. and held all the shares, except for one. The company was
formed to undertake the business of aerial crop spaying. Lee was employed as the companys
pilot. He was killed in an accident while carrying out his work. His wife claimed workmens
compensation under the New Zealand law, and she could only succeed if she could show that
Lee was in effect an employee.

The Privy Council held although Lee was the controller of the company, personally he was
separate from the company. He could enter into a contract with the company, and could be an
employee.

Can Sue and be Sued

as the company is a separate legal entity, it can sue and be sued in its own name. It can sue in
respect of rights that it has, and if it has liabilities, others may sue against it. The members of
the company generally cannot take any legal action on behalf of the company. Only the
company itself can enforce its rights. This is called the proper plaintiff rule and it was
established in the case of:

Foss v Harbottle (1843) 2 Hare 461

Two shareholders of a company brought action against directors of the company for
misapplication and improper use of the companys property.
The court held that as the injury complained of was injury to the company and not to the
members. As such the members could not take action. Only the company had the right to sue.
3.2 A company is a separate legal entity as distinct from its members

A company is a separate legal entity as distinct from its members, therefore it is separate
at law from its shareholders, directors, promoters etc and as such is conferred with rights
and is subject to certain duties and obligations.

These central principles of company law were first laid down in very clear terms by the
House of Lords in the case Salomon v Salomon & Company Ltd [1897] AC 2.

The ruling outlined in part in the quoted text of the assignment from Lord Macnaghtens
ruling has several important consequences, not least that where the liability of the
members is limited, they cannot, only in exceptional circumstances be held liable for the
companys debts.

Under the concept of Limited liability the owners of the company under normal
circumstances, are not answerable or responsible for the obligations of the company
therefore making the owners/ shareholders liable only for the amount of their unpaid
shares and not the obligations of the company.

The principle from the Salamons case firmly established that a company has a separate
legal identity to that of its shareholders and has been applied over a wide range of cases.

Roundabout Ltd v. Byrne [1959] IR 423

The owners of a public house when in dispute with its employees, who had placed a
picket on the premises transferred the pub to a company. The court held that the picket
must be lifted as there was no dispute between the employees and the new owner, despite
the fact that the ownership of the company was vested in the original owners of the pub.

Battle v Irish Art Promotion Centre Limited [1968] IR 252

The court held that while a human person can represent himself in Court, a legal person
such as a company can only be represented by a Solicitor or Barrister.

The principle set down in Salomon v Salomon & Co is known as the Veil of
Incorporation. However it is now been increasingly restricted in its application to an
increased extent by legislation in order to prevent the abuse of limited liability protection
and to ensure that liability for tax is not being avoided.

The veil of incorporation may only be disregarded by the court in certain circumstances.

Re a Company (1985)[1985] BCLC 333

The court held that it would use its powers to pierce the corporate veil if it felt it was
necessary to prevent an injustice.

3.3 Reasons of creating separate legal entity in a company

Tax Issues

Many startups begin as sole proprietorships or general partnerships. Theyre easy to form
and the pass-through nature of taxation may make sense for an enterprise where initial small
profits are likely to be re-invested in the business immediately. The double level of taxation
for a corporate entity seems like a correspondingly terrible idea. LLCs may choose to be
taxed as partnerships rather than corporations. But now, your business has grown. Is it time
to take some profits out?

Liability Protection

On the other hand, unlike corporations or LLCs, sole proprietors and general partners have
unlimited personal liability for the debts of a business. General partners are also fully liable
for the consequences of business actions taken by all other partners. That risk may be far too
much to stomach for a business that serves food to the public, but somewhat more tolerable
for an online sales business. It might make sense to organize the restaurant and food truck as
corporations or LLCs, even if, for other reasons, it still made sense to keep the online sales
component as a sole proprietorship. It might also make sense to insure the businesses as
separate entities. Food service risks and order fulfillment risks are different.
What if the restaurant actually owns the valuable piece of real estate on which it sits? Its
somewhat uncomfortable to have the most valuable asset owned by the riskiest enterprise.
We have been considering dividing the business by enterprise. Might it make sense,
instead, to divide it by function into real estate, management and operations entities? The
liability question may vary somewhat by state. In Texas, for instance, because it is a charge
order state, judgments against the business may only be satisfied through application of
receipts, rather than existing assets.

Management Structure

Sole proprietors have the ultimate freedom in business decision making. General partners
share it equally. Exactly how comfortable are you with your partners judgment? In a limited
partnership, the general partner makes all the decisions. In a traditional Subchapter C
Corporation, the shareholders elect a Board of Directors that makes decisions. An LLC may
be either member managed, much like a general partnership, or manager managed, much like
a limited partnership. This only scratches the surface of possibilities.
Management freedom is only one part of the equation. Investors may prefer a management
structure in which they have some control. As a business owner, you may want to establish
credit for your business that is separate from your personal credit. This may be easier with a
corporate (including LLC) business entity.

Transferability

This includes succession planning, as well as the possibility of stock or asset sales. Some
forms of business are easier to transfer than others. If you want to run the restaurant well into
your dotage, then leave it to your kids, but are considering franchising the food trucks and
selling the bottled sauce business to make a quick buck to finance expansion of the restaurant,
it might be worth separating them into independent business entities, and structuring each
to maximize profit. Perhaps you dont want to sell the whole business immediately, but
transfer control of an increasing interest as certain benchmarks are achieved?