CORPORATIONS LAW NOTES: INTRODUCTION TO CORPORATIONS LAW:

Transcription

1 CORPORATIONS LAW NOTES: INTRODUCTION TO CORPORATIONS LAW: Origins of the company: Multinational Corporation: in 1897 the landmark case of Salomon v Salomon began to cement the role of the corporate form within the contemporary economic framework. The case created the attributes of limited liability and separate legal entity; and embedded these concepts into the CL.! Birth of the MNC allowed one company to own another, and as a result capital could be increased. How are corporations governed? Like governments, corporations are required to adhere to certain internal governance procedures. It is the corporate constitution that provides the framework for this governance. Directors are the most important organs of a company, however they are not the only decision-makers within a company. TOPIC 1: NATURE, FUNCTION, ORIGINS AND REGULATIONS OF COMPANIES- Nature and functions of companies: *A corporation (body corporate) is a legal device by which legal rights, powers, privileges, immunities, duties, liabilities and disabilities may be attributed to a fictional entity equated for many purposes to a natural person. *A corporation is formed by registration under s.119 of the Corporations Act (CA). s.119 defines a registered company, which comes into existence upon registration. S.124 states the legal capacity and powers of a company; and as these rights of corporation under s.124 are sourced in statute, they trump the CL.! ASIC acts as an agent of the State to confer the benefit of incorporation upon a company. Therefore, only the State can create this artificial body. Entities may become incorporated through legislation other than the CA. How are companies used? Functions of a company include:! (1) Limiting liability of participants in an enterprise! (2) Marshalling participants in large commercial enterprises! (3) Providing a regime for co-enjoyment of property! (4) A structure for a corporatized government enterprise

2 ! (5) A structure for fund management! (6) A structure for continuing trusteeship! (7) A structure for holding family assets! (8) A structure for a joint venture! (9) A nominee to hold the legal title to assets *The main function of a corporation is to conduct enterprise so that the person interested in the enterprise can limit their exposure to the liabilities of the enterprise; and can raise large amounts of capital.! Main functions of corporation: limiting liability and raising capital. Advantages of corporations when compared to other alternatives: Separate legal entity and limited liability: members liability to further pay money is limited to the amount (if any) remaining on unpaid shares. Perpetual succession-a company will continue beyond the life of those involved in it. Transferability of interests-companies provide for unfettered transferability of interests (i.e. can sell shares without too many complications), whereas in partnerships; partnership interests cannot be assigned.! Shares are a fungible security capable of being traded through organised markets. Corporate law as standard form contract-once a corporation is created, the need for insurance to limit liability disappears, as does the need to create a contract to limit liability. Certainties: death and taxation. Taxation impacts on the structure of an entity: the corporate tax rate is a fixed rate, and franking credits mitigate the risk of double taxation. Disadvantages of corporations when compared to other alternatives: Costs associated with formation; Ongoing maintenance of public records: there is a need for corporations to maintain records and submit forms to ASIC. This involves professional fees and time. Public law obligations: breaches of corporate management responsibilities will import criminal sanction. This is because incorporation is seen as a privilege, and therefore participants are required to adhere to these obligations. *The main factors that will determine the decision as to what legal structure will be appropriate are: Size of business (cap on member numbers)

3 Taxation rates and structures Liability for debts Establishment and Operational costs and expenses Ability to raise capital / transfer interest (eg partnership goodwill is a CORPORATE GROUP T asset realisation) Level of managerial control [may want limited control] Size and timing of profits Continuity of existence; and Reporting/accountability Alternatives to a company: Sole trader: The sole trader is the simplest legal structure usually the business is run under the name of a person, although it is possible to register a business name under a sole trader arrangement. It is not a separate legal entity, so the owner is liable for all the debts of the entity. Partnership: The Partnership Act 1895 (WA) defines partnership as the relation which subsists between persons carrying on a business in common with a view of profit' (section 7). There are no formal requirements to establish a partnership. All that is required is that the 3 elements under s.7 are satisfied. When contrasting a company from a partnership, there are some key distinguishing considerations: Ownership of property, Rights of creditors, Agency: s.16 indicates that partners will generally be considered jointly liable but s.17 indicates that partners can be jointly and severally liable.! Partners personally are jointly and severally liable for torts committed by the partners and liable to pay debts incurred by the partnership. Contractual relations Personal liability, and Management of the business. Limited liability partnerships: Although the general rule is that partnerships do not gain the advantage of limited liability, this needs to be qualified by the fact that there is a distinction to be made between a general partnership and a limited partnership.

4 ! These types of partnerships are not particularly popular. Membership quantity restrictions: under s.115 of CA, a person is prohibited from participating in a partnership where there are more than 20 members, unless the regulations specify a higher number.! Generally, there are no limits on the number of members in a company. However, generally if there are more than 50 members, ASIC may require the corporation to become a public company. Partnership agreements-whilst there are no formal requirements to establish a partnership, in practice there is typically a written agreement that underpins the arrangements.! If there is no partnership agreement, then the Partnership Act will apply by default.! Partners have a fiduciary relationship, many of which are embedded in the Partnership act: these include s.30, 31, 40, 41. Entering, leaving and dissolving:! Entering-S.34 Partnership Act: no person can be introduced as a partner unless all of the existing partners consent.! Leaving-S.35-there is no ability to forcibly expel a partner unless such is agreed in writing in the partnership agreement.! Dissolving: capital gain taxation may come into play if someone is removing themselves from a partnership. This is bcs assets, such as goodwill may be enacted by virtue of getting out of the partnership. Joint ventures: Occur where there are several persons participating in a single project. Joint ventures can be incorporated or unincorporated. Incorporated JV: usually there is some type of special purpose company established; so the company itself fulfils the project, and the participants in the joint venture are shareholders in this special purpose company. Unincorporated JV: can be difficult to distinguish these from a partnership.! Courts tend to focus on whether the 3 elements in s.7 of Partnership Act are present, rather than on the name of the entity.! Companies entering into an unincorporated joint venture can overcome being deemed a partner. One of the ways an unincorporated JV will avoid a partnership determination is to share a product rather than share the profits. This way a company can avoid the fiduciary obligations attached to a partnership.! E.g. instead of acting in a business in common with a view to profit; an entity will act in a business in common with a view to i.e. extract resources (mining companies).

5 United Dominions CorporationPty Ltd v Brian Pty Ltd (1985)- JV deemed to be a partnership.! 3 parties were seeking to form a shopping centre; in the course of this, there was a Q as to whether one party owed money to another. That Q was to be determined by considering whether a partnership existed between the 3 parties.! HCA HELD-even though the parties described the arrangement as a joint venture, the arrangement was actually a partnership, bcs the parties were carrying on a business in common with a view to profit.! *Principle: it does not matter what the parties call the arrangement; the courts will look as to whether the 3 elements contained in s7 of the Partnership Act are present. Trusts: A trust may be defined as an obligation enforceable in equity which rests on a person (the trustee) as owner of some specific property (the trust property) to deal with that property for the benefit of a certain person (the beneficiary) or persons, or for the advancement of certain purposes. Trusts are often used in family business (taxation reasons-income splitting). There are also trading trusts-used in accounting firms (income split and protect assets). Unit trusts-rights to trust capital and income are generally split into units (like shares), and the units of the trust represent the rights of the beneficiaries. Origins of company law: Australian company law is primarily based on the UK precursors: this helps to distinguish the importance of previous UK decisions; and helps to determine whether law reform may be adequate. The need for corporations: Makers of law find it necessary to create artificial legal entities, that facilitate the enjoyment of legal rights. English judges and lawyers in shaping the CL developed two main types of corporation: corporation sole and corporation aggregate. Corporations sole: arose in England in the Middle Ages to facilitate the holding of church property by an occupant of a particular office. The Bishop was treated as an artificial person, to whom the title of property was vested. This way, the individual who occupied the office came to represent the corporation. Corporations aggregate: it is a legal entity constituted by two or more members (corporate or individual) associated for some common venture or by a single member with whom others could associate for some common venture.

6 ! From about the 15 th century through to the 19 th century, there was the emergence of corporations aggregate along with the emergent concept of joint stock.! Corporate aggregate became a means for conferring on a group of people the capacity to hold and deal with property and interests, to advance the aims of a collective.! Prior to the 16 th century; a corporate aggregate could only be created by the Monarch granting a royal charter. These royal charters were difficult to obtain.! A charted company would often obtain monopoly rights to control the operation of a particular trade. Joint stock: during the 18 th century, larger commercial activities required a greater amount of capital than a single individual person could provide. There a pool of capital was needed to conduct certain activities.! A person could invest a sum of money in a venture, and receive in return an entitlement to the future profit stream.! Joint stock was transferable and could be sold by the investor without the consent of the other investors.! A joint stock company was basically a partnership, but allowed for transferability. Each person was liable for the liabilities of the ventureunlimited liability. Deed settlement companies: were essentially a combination of partnership and trust. During this era 1800s another popular legal structure that emerged in England was that of deed settlement companies.! Under this legal structure, the assets of the partnership were held on trust by the trustee; with the venture being managed by agents.! The venture didn t have a separate legal personality. The trustees held the property rights.! Investors received a share that represented an interest in the trust property-articles of association. Joint stock companies: in the UK: Joint Stock Companies Registration and Regulation Act 1844 (UK) allowed any group wishing to form a company for a lawful purpose to apply for registration.! At this stage, there was no limited liability; but in 1855, the Limited Liability Act 1855 (UK) was enacted.! Procedures for incorporation and how a company could be wound up were contained in the Companies Act 1862 (UK).! This Act was adopted by the Australian States, and used as the model for Australian Companies legislation. Australian Legislative Arrangements-desire for uniformity:

7 ! Before federation in 1901, each Australian colony had companies legislation based on the Companies Act 1862 (UK).! When on 1 January 1901 the Australian colonies became states sharing legislative power with the Cth, they continued to be responsible for companies legislation.! By the 1960s, there were calls from commercial interests for companies legislation to be made uniform across Australia.! The Cth created a number of cooperative schemes, which were held by the HCA to be unconstitutional, as the separation of powers doctrine creates difficulties when States try to cross-vest their jurisdiction to Federal Courts-see Re Wakim; Ex parte McNally.! Referral agreement by States: all States agreed to refer corporations and related matters to the Cth to enable the Cth to enact the current Corporations Act 2001, and the Australian Securities and Investments Commission Act 2001; both Acts relying to a large extent on s.51(xxxvii) of the Cth Constitution.! These referral agreements are renewed every 5 years.! Problems have arisen in relation to word formed under s.51(xxxvii); which created difficulties for the Cth in allowing for the creation of a company.! ASIC Act allows for ASIC to act, as an agent of the Cth. ASIC is only responsible to Cth Parliament, and the relevant Cth Minister. State governments or Parliaments do not have any power to control ASIC. Theoretical foundations: (1) Separate legal person model: under Salomon there was a significant shift away from incorporation as a privilege; towards seeing the corporation as a manifestation of the freedom to contract and engage in entrepreneurial risktaking with limited liability.! This model tends to lead to the privatisation of benefits and socialisation of costs-seen during the GFC. (2) Stakeholder approach: The UK Companies Act 2006, s 172 imposes a duty on directors to promote the success of the company having regard to a list of factors which represent different stakeholder interests.! Stakeholders are broad-creditors, customers, and public at large.! Triple bottom line approach stems from the stakeholder approach. (3) Managerialist theory: regulation is to be used to ensure that agents of companies act in the best interests of the company. Regulation is needed to ensure that directors act in the best interests of the company.

8 (4) Contractual theory: try and avoid regulation at all costs, and rely on the market to discipline bad behaviour. When those that act on behalf of company as agents, misbehave, then the market will discipline them through the means of corporate takeover. Therefore no regulation is needed to ensure the directors behave, providing the market is functioning effectively. Regulating companies: Main regulatory bodies in the Australian system of corporate regulation:! Cth Parliament, which by legislation prescribes the standards to be applied to companies and persons connected with them and delegates to the executive government power to prescribe subordinate legislation.! Parliaments of states, which have supported the Cth legislation by referring legislative power to Cth parliament.! Executive arm of government acting through a Cth Minister and regulatory authorities-asic;! The judiciary, through which the prescriptions of law-makers are interpreted and applied to the facts of a case before a court.! ASX-for companies wanting their shares quoted on the stock market. ASX is co-regulated by ASIC! Matters of company accounting and auditing: Financial Reporting Council; Australian Accounting Standards Board; Auditing and Assurance Standards Board.! Australian Institute of Company Directors.! Australian Competition and Consumer Commission Main features of regulation of companies:! Prescription by the Cth legislature of the conditions for the formation, operation and winding up of companies;! Registration of companies by ASIC;! Maintenance by ASIC of registers open to the public on which significant information about companies and persons connected with them can be entered;! Policing by ASIC of legislature prescriptions;! Exercise by ASIC of discretions conferred on it by the legislature to grant exemptions from prescriptions or vary them;! Publication by ASIC of info about the exercise of its discretions and its policies and procedures;! Supervision of the winding up of companies, a function allocated to the judiciary (superior courts). TOPIC 2: INCORPORATION AND ITS CONSEQUENCES-

9 Effect of registration on a company: *A company is created as a discrete legal entity when ASIC registers it following an application made by a person, whether corporate or individual, under s.117. S.118 directs ASIC upon registering a company to issue a certificate of registration stating:! the company s name;! its Australian Company Number (ACN);! that the company is registered as a company under the Corporations Act 2001;! the state or territory in the jurisdiction governed by the Corporations Act in which the company is taken to be registered (s.119a);! the date of registration. *When s.119 provides that the company on registration comes into existence as a body corporate, it impliedly states that the company comes into existence with the attributes given by the CL to a body corporate, except so far as the CA or other legislation modifies or supplements those attributes. *Corporation vs company: Although the words company and corporations are mostly interchangeable, technically a company is one type of corporation-s.57a.! Company evolved from the UK statutory initiatives, flowing from joint stock companies legislation.! Whereas in the US, corporation stemmed from the royal charter perspective of businesses which dominated at the beginning of the industrial revolution.! *There is a slight technical difference between company and corporation, however as far as the CA is concerned, S.57A indicates that a corporation includes a company. This means that all companies fall under the umbrella of corporations; but not all corporations can be considered as a company.! S.9: defines corporation and company. Under s.9, a company is one registered under the Act. TYPES AND FORMATION OF CORPORATIONS:

10 There are corporations under CL, under statutes and under specific corporate legislation.! Under CL: royal charter-this notion stems from the CL history of a corporation. In order for a corporation to exist historically, it was required to have a specific objective and was constrained by time limitations i.e. perpetual succession did not always apply to the corporate form. The issuing of a royal charter equates to corporation aggregate i.e. an artificial legal person representing a group of individuals existing at the same time. AND corporate sole-particiular legal person who holds property. Statutory corporations: both Cth and state governments can create these types of corporations. Typically they are set up to fulfil some type of public function that is independent from the government itself.! ASIC: CA authorises ASIC to grant incorporation on application. When ASIC registers a company, they become a corporation aggregate.! Incorporated associations-usually used by social clubs and environmental associations. Usually are registered through state based legislation rather than through Cth legislation (for constitutional reasons). Corporation aggregate at CL: In Australia, the GG can create corporate aggregates through a royal charter. Institute of Charted Accountants falls under this stream. At CL, by the late 18 th century various powers were inseparably incident to a corporation aggregate created by royal charter. *Section 124 of the CA outlines the powers of a body corporate:! (a) the power to sue or be sued in the corporate name

11 ! (b) the power of taking in new members until the corporation was dissolved-perpetual succession! (c) the power to have a common seal with which to show its corporate assent! (d) the power to hold property! (e) the power of making rules for the internal government of the corporation. Separate legal entity: Sir James Smith s case: it was said that a corporation is an artificial body composed of divers constituent members like the human body, and that the ligaments of this body politic or artificial body are the franchise and liberaties thereof which bind and unit all its members together, and the whole frame and essence of the corporation constist therein.! This case elaborated on the idea of legal fiction, and the court referred to a corporation as an artificial body which is composed of diverse constituent memebrs, like the human body i.e. the board of directors is the mind, and the hands are the agents of the company. H L Bolton & Companyv T J Graham & Sons: Denning LJ said a company may in many ways be likened to a human body. It has a brain and a nerve centre which controls what it does. It also has hands which hold the tools and act in accordance with directions from the centre. Corporate veil: *A company is a legal entity separate from the legal persons who became associated for its formation or who are now its members and its directors. For certain purposes, there is a corporate screen around the members and directors. This screen is known as the corporate veil.! The company itself has legal rights, privileges, duties or liabilities that belong to the company and do not attach to the members or directors of the company.! *This corporate veil was eluded to by Kitto J in Hobart Bridge CompanyLtd v FCT (relying on statement by Lord Summer in Eng case Gas Lighting Improvement CompanyLtd v IRC:! Between the investor, who participates as a shareholder, and the undertaking carried on, the law interposes another person, real though artificial, the company itself, and the business carried on is the business of the company, and the capital employed is its capital and not in either case the business or the capital of the shareholders. Assuming, of course, that the company is duly formed and is not a

12 sham the idea that it is mere machinery for effecting the purposes of the shareholders is a layman s fallacy! Providing, the company is properly registered, then it is not a sham and the law will uphold the idea of corporate veil: Salomon. Agency: *Although a company is a separate legal entity, a company can only act through its members, agents and directors. The board of directors controls the actions of the company; however in some instances the members can also act as an organ of the company (particularly through the general meeting of the members). *Even if a company only has one member, it is a separate legal entity and its rights, duties, liabilities and privileges are separate from those of its sole member-salomon. Salomon v Salomon & CompanyLtd:! Mr S was a sole trader of a leather and boot manufacturing business. At the time of the case, the Companies Act 1862 (UK) required that a company have 7 members in order to be legitimate.! Together with his wife and 5 adult children, Mr S registered a limited company under the Companies Act.! Mr S was the managing director, and his 2 eldest sons were also directors.! His wife and children voted at the company meetings in accordance with Mr S directions-so Salomon controlled the company.! Mr S sold his leather and boot business to the company for 40,000 pounds. The company paid part of the price by allowing Mr S shares in the company; with a large part of the purchase price being left outstanding as a debt of the company (this debt was in the form of a hundred 100 pound debentures).! So Mr S was both a substantial shareholder in the company and a large secured creditor.! The company failed with debts owing the outsiders, and in the winding up of the company, the assets were insufficient to meet both the secured debt to Mr S and the claims of the unsecured creditors in full.! Normally the secured debt would be paid in priority to the claims of the unsecured creditors, but the liquidator tried to have the secured debt postponed to the claims of the unsecured creditors.! The liquidator tried to establish a counterclaim by the company against Mr S which would reduce the amount of the secured debt. He

13 argued that the company had really been Mr S agent when it conducted the business.! Liquidator drew attention to the fact that Mr S had a high degree of control over the company. In particular, he argued that under agency law, Mr S was required to indemnify the company-which meant that the company was entitled to claim over Mr S personal assets in the company s possessions.! First instance: Vaughan Williams J: held for the liquidator. He reasoned that the company conducted the business not in its own right but as agent for Mr S; Mr S (the principal) was bound udner agency law to indemnify his agent (the company); and the company as Mr S agent was entitled to a lien by operation of law on its principal s assets in its possession.! *On appeal: noted that the sale and transfer could not be ignored, and although the company became the owner of the business and conducted it as a principal, the high degree of Mr S control and the fact that 6 other shareholders were not independent still meant that the company was conducting the business on behalf of Mr S.! *The Companies Act (UK) did not allow a sole trader to obtain limited liability by forming a company in the manner in which Mr S had i.e. where one person is controlling the company and there are 6 other shareholders being directed what to do (and are not independent).! *House of Lords: unanimously held against the liquidator. It held that the company had conducted the business in its own right for itself beneficially and beither as agent nor trustee: it was not just an alias for Mr S. the 7 persons required for the formation of the company did not have to be independent of each other; aand Mr S was not liable to indemnify the company. Hence, the debt for which security had been given to Mr S could rank before the unsecured creditors in the distribution of the company s assets. *The common law has become entrenched with many statutory initiatives; so no longer have to rely on Salomon bcs s.124 encapsulates the principle of the case.! S.124: granting of a floating charge-a way of borrowing money against assets that would otherwise be moving around. Lee v Lee s Air Farming: *under the separate legal entity doctrine, a member, even a controlling shareholder, can contract with the company.! L formed a company to conduct a business of aerial topdressing, he being the sole beneficial shareholder.

14 ! He was also the sole governing director, appointed for life, but he could retire and the office would be vacated in the event of his becoming bankrupt and in certain other events.! L contracted with the company to work as chief pilot. While working for the company, L was killed in circumstances giving rise to a claim against the company for workers compensation, provided L was a worker within the meaning of the workers compensation legislation.! Worker was defined as a person who has entered into or works under a contract of service with an employer.! A claim by L s widow for compensation was defended by the company at the instance of the insurer.! NZ CA held: that L was not a worker because as governing director he could not give directtions to hismefl as a pilot.! *PC: reversed the decision because under Salomon, L could act in two capacities: as the organ of the company and as an employee. It was also possible for him to bind himself by contract to serve the company for a term. If during that term he ceased to be controller of the company, he would as employee be subject to the directions of new controllers.! *The fact that as controlling shareholder he could control the course of events did not affect the validity of the contract between the company-a separate entity and himself.! *Policy issues: generally in contract law, there is a requirement for meeting of the mins in order for a contract to come into being. This case suggests that where the parties are a corporation and its controller, and the two parties share the same mind, consensus can be arrived at without going through the ordinary pre-contract processes of negotiation leading to consensus. It is possible for a valid contract to be formed between the two parties. Macaura v Northern Assurance Company*a company holds its property separately form the property of its members.! M owned an estate. He sold the timber on the estate, both felled and unfelled, to a company for 42,000 pounds. He received the price in 42,000 fully paid 1 pound shares.! M and his nominees were the only shareholders. The company s onlysubstantial asset was the timber on M s estate. M financed felling of all timber on the estet and the company owed him 19,000 pounds.! M and the bank took out insurance policiies with D in their joint names for their respective interests, insuring them against loss by fire on the felled timber up to 30,000 pounds. Most of the timber was destroyed by fire.

15 ! The insurance company refused to pay on the ground that M had not, either as a shareholder or as a creditor, any insurable interest in the timber, which belonged to the company.! *The insurance company s refusal to pay was upheld by the HL.! *Lord Sumner: said that M stood in no legal or equitable relation to the timber at all. He had no concern in the subject insured. His relation was to the company, not to its goods, and after the fire he was directly prejudiced by the paucity of the company s assets, not by the fire.! M could have recovered if he had insured against loss of value of his shares or less than full recovery of his debt caused by the fire.! When M transferred the timber to his respective company, the transfer was a real transfer in law from one person to another and not a sham. However, M did not retain any legal or equitable interests in the asset transferred. After the transfer, M owned shares and a debt rather than a beneficial interests in the timber.! *Shareholders have no legal or equitable interest in the company s property. Property owned by the company is not owned by its members. Lifting the veil: Lifting the veil: is concerened with accessing the shareholders behind the company; whereas piercing the veil relates to atrtirbuting to the shareholders the rights and liabiltiies of the company. However, in practice these terms are used interchangeably. *Lifting the veil: the existence of the company is accepted, but instead of the company remaining opaque it is made transparent so that in a proper case the persons behind it can be seen as the persons to whom the corporate right, privilege, duty or liability can be ascribed.! Therefore lifting the veil is an exception rather than a rule. Courts have generally had a great reluctance to undermine the principles of limited liability and separate legal entity.! *Lifting the veil does not equate to denying the existence of the company; rather the existence of the company is accepted as well as the attributes of the company.! S.124: the allocation of various powers to the body corporate includes: issuance and cancellation of shares/debentures; grant options; give security by charging uncalled capital-i.e. if a share is partly paid, then the owner of the share will need to pay up on the uncalled capital when asked to do so.

16 Agency: a company can only act through humans, who are authorised to act or to act on behalf of the company. These agents include directors, officers and employees. *Limited liability: most companies are limited by shares in which eah shareholder s liability is limited under the CA to the amount they, or earlier holders of their shares, agreed to pay the company for the issue of their shares.! Limited liability serves to shift risk from shareholders and company directors to other third persons who deal with the company, such as creditors and employees. 5 reasons why limited liability is of benefit to shareholders:! (1) It decreases the need for shareholders to monitor the managers of companies in which they invest because the financial consequences of company failure are limited.! (2) It provides incentives to managers to act efficiently and in the interests of the shareholders by promoting the free transfer of shares.! (3) It assists the efficient operation of the securities markets because, the prices at which shares trade do not depend upon an evaluation of the wealth of individual shareholders.! (4) It permits efficient diversification by shareholders which in turn allows shareholders to reduce their individual risk. It also permits companies to raise capital at lower costs because of the reduced risk faced by shareholders.! (5) It facilitiaes optimal investment decisions by manangers Limited liability and separate legal entity concepts: the purpose of these principles is to encrouage enterprenurial risk-taking. However, there are laws (such as tort law) that seek to discourage this risk-taking.! Facilitation of enterprenurial risk-taking vs other considerations i.e. tort-vicarious liability, negligence! S.588G: directors will be liable if the director knows that the company they are directing is inolsvent. This shows where the veil of the corporation will be piereced, bcs even though the policy is to encourage entrepreneurial risk-taking, that risk-taking should not be reckless. Lifting the veil-common law: *Salomon: even where a company has only one member who controls it, this does not mean that the courts will be more likely to lift the corporate veil. Further, it is not enough to that the outcome of a particular case

17 leads to an unfair result i.e. Salomon-unfairness to unsecured creditors alone will not warrant the lifting of the corporate veil at CL. *Generally, in order for courts to lift the veil the relevant activity will need to fall into a category: Roger J in Qintex- where a corporation is used as a vehicle for fraud; where a company is established to avoid legal obligations; or where there is a breach of directors duties. Company used as a vehicle for fraud: Re Darby: director and G registered a comapny inone of the Channel Islands. They were sole directors of the company, and also shareholders along with 5 other shareholders.! Channel Islands comapnay bought a license to work a slate quarry for a small price. The company then registered another English company called Welsh State Quarries. This English company issued a prospectus and shares to the public; it then used the funds from the share issue to buy the quarry license from the Channel Islands company for a very inflated price.! D and G therefore acquired a profit and divided the profits between them. English comapnay failed and was wound up.! The liquidator of the English Company sought account of profits from D, bcs director as director of the English Company had acted in breach of his duty as a promoter.! D argued that the Channel Islands company was liable for fraudulent staetments as it was the company that set up the English company, not director personally.! D also argued that the profits were made by the Channel Islands company, and not him personally.! director was relying upon a strict interpretation of the separate legal entity concept to avaid an accounts of profit claim.! *Court held: that the Channel Islands company was formed as a part of a fraudulent plan. Although ordinarily the Channel Islands company would have been the promoter; because of the fraudulent design of director and G, the court looked behind it and treated director and G at being the true promoters of the English company-this was bcs they had not made adequate disclosure required of promoters to ivnestors in the English company about their profit; so the liquidator was entitled to share in D s bankrupt estate in respect of D s share of undisclosed secret profit.! *Where a company is being used as a vehicle for fraud, then the courts will often be willing to lift the corporate veil.

18 Company is used to avoid legal obligations: *It is acceptable for someone embarking on an enterprise which may attract future obligations and liability to form a limited company to carry on the enterprise-adams v Cape Industries. However, where persons who are already under an existing obligation form or acquire a company to engage in conduct which, if engaged in by those obligors, would be breaches of their obligation and the aboidance of that obligation is the sole, or the dominant, intention of the obligors in forming or acquiring the company. *If the avoidance of an existing legal obligation is the sole or dominant intention of the obligors in forming a company, then the court may lift the corporate veil. Gilford Motor Companyv Horne: H was appointed managing director for G Motors for 6 years. As part of the agreement, GM agreed that it would engage in restraint of trade i.e. it would solicit or entice competitors away or clients away from GM Co.! 3 years later, H set up a business in his name in competition with GM Co, and subsequently H received advice from his solitior to set up a company in his wife s name, which he agreed to do.! Evidence showed that the creation of the company was bcs H feared he would be breaching his restraint of trade clause that he signed with GM Co.! GM Companysought and received an injunction to restrain H and his company from soliciting GM s clients.! *Court held that H s company was a sham, which was set up as a device to permit H to breach his obligations owed to GM.! *Case shows where a company was formed for an unlawful purpose of assisting H to break his contract, and was restrained from implementing that purpose-an injunction was granted to prevent the company from implementing that unlawful purpose. Jones v Lipman: L contracted to sell land to the Ps. Before the contract was completed, L acquired a company to which he sold the land.! L and his solicitor s clerk were the sole shareholders of that company. The price paid by the company for the land was much lower than the price payable by the Js.! Js sued L and the company for specific performance.! Russell J: held for the Js. Specific performance could be ordered against L. As controller of the company he could compel it to transfer the property to the Js. Specific performance was also