Separate Legal Entity of a Company

The author in this case discusses the concept of Separate Legal Entity of a company and the judgments dealing with the same. The author further discusses the Doctrine of Lifting of the Corporate veil with the help of case law.
Estimated Reading Time: 11 minutes

Introduction

The word “company” is defined in clause 20 of section 2 of the companies Act, 2013, it is as follows: “Company” means a “company incorporated under this Act or under any previous company law”. This definition in the Act does not disclose the real meaning of the word “company” and its “characteristics” like separate legal entity.

Characteristics

The term ‘company’ is nowadays used to denote a large organization that undertakes commercial and business activities. It is a loose definition. Another way in which a company can be defined is as an association of persons coming together to conduct some business or commercial activity for gain. A technical term would be an association of person coming together while contributing some money that is known as share capital of that company. This share capital is used to conduct further business of the company. The association of persons will have a separate name and the profits of this association will be divided among the members depending on their share of contribution in the capital share of the association. The association will be incorporated (registered) under the Companies Act and thereafter it will be a legal person having an artificial personality.State Trading Corporation of India Ltd. v. the Commercial Tax Officer,[1] the Supreme Court held that “though a company is a legal person/juristic person or a person in the eye of the law, it is not a citizen of India. So, it cannot enjoy the fundamental rights guaranteed by the Constitution of India and the provisions of Citizenship Act”.

The State Trading Corporation of India Ltd. & Others v. The Commercial Tax Officer, Visakhapatnam and Others

A company is said to have legal personalities as a legal person. But despite being a legal entity, a company is not said to be a citizen under the Constitution of India. The Citizenship Act doesn’t recognize an artificial person such as a company a citizen under it either. Subsequently, a company is said to be deprived of the fundamental rights guaranteed by the constitution of India and the Citizenship Act.

Facts

  1. In the states of Bihar and Andhra Pradesh, the tax authorities in charge of sales brought a new policy to bring the corporations in their purview and assess them under the sales tax regime. Subsequently, a notice of demand was issued.
  2. When brought to the corporation’s notice, the corporation claimed they were citizens of the country and therefore filed a petition under Article 32 of the Indian Constitution. The petition sought the quashing of the orders that were issued by sales tax authorities. The claim was the infringement of the corporation’s fundamental right under Article 19(1)(f) & (g) of the Indian Constitution.
  3. It was also held by the court that “The precedents of the Supreme Court of the United States which hold that corporations are citizens of the State of incorporation for purposes of federal jurisdiction cannot be followed in India. The diversity of citizenship which has led to such rulings does not exist in India”.

Issue

  1.  The issue of the case was whether the corporation is a citizen within the meaning of Article 19 of the Constitution and can subsequently ask for enforcement of the fundamental rights that are granted to a citizen. 
  2. Another issue was whether the corporation is, in substance, an organ/subsidiary/department of the GOI with almost the entirety of its capital share being contributed by the government; and thus, can the corporation claim fundamental rights under part III of the Indian Constitution.

Judgement

  1. A corporation based on its registered office and place of doing business can have a claim of nationality. But the reasoning given behind denying citizenship claimed that while nationality can be given to natural and artificial entities, citizenship is connected to civic rights that are given under the municipal law and not given to the artificial legal entity.
  2. The citizens of a state nonetheless, enjoy political and fundamental rights. This is not true for all nationals of a state. The ambit of Article 5 of the Indian Constitution is not as wide as the ambit of Article 19 of the Constitution. This meant that not everyone enjoyed natural citizenship. That is a corporation.
  3. Thus it proves that the corporation was therefore not a citizen though any laws existing at the time and were just an artificial entity. The nationality of a corporation cannot be used to 0determine the fact of whether it will have fundamental rights or not. Thus, the nationality of the corporation did not confer it with fundamental rights under Article 19(f) & (g). Upon lifting the veil, it can be said that the corporation or the State Trading Corporation was a department of the government.
  4. Another feature of a corporation is that a corporation or a company is not the same as its members or shareholder. It has distinct characteristics that do not depend on the citizenship of its members.
  5. The Case relied on various case laws and established a fundamental characteristic of a company and helped in the development of the definition of a company as an association of people coming together to do business. Furthermore, the judgment gave companies the nature of a legal entity.[2]

Analysis of the judgement

  1. The decision by the court was correct as persons and members can ultimately utilize these rights, not for a good purpose but the cons outweighed the pros. Moreover, the legal consequences of such a decision would alter the understanding of what a citizen and a company are. Tangible and other factors of a citizen do not apply to a company
  2. The court cleared the question of law with the utmost quality and the judgment is likely to be remembered for being an accurate one. It answered one of the most pertinent questions of law regarding the companies Act. Thecase was disposed of with the decidedly correct decisions made by the bench.
  3. Concluding remarks- A company is a “corporation aggregate”. It will thus likely be known by its name and not its members. This is what it means to have the characteristic of “perpetual succession”. It is a separate legal entity in the eyes of law. A company through its virtues can acquire properties and assets of its own. A company can also in certain cases contract debt and liabilities for the same would be of its own. It can acquire properties in its name. It can contract debts. The liability of the company will be of its own. The member’s liability will be only to the extent of the value of the shares they hold in the company. The company may have a common seal. It is the signature of the company. Before the amendment in 2015, the requirement of a common seal was mandatory. Now it is optional. Section 9 of the Act, 2013 has been amended in 2015 and the words “and a common seal” have been omitted. The result is that now a company need not have a common seal.

Some Essential characteristics of a registered company are:

  1. LEGAL ENTITY- Section 9 of the Indian Companies Act, 2013 has an effect of making the association a legal entity. It is a separate entity from its shareholders/members. The company decides its name and seal. The assets of the company are held by the company and are separate from its member’s assets. The “separate legal personality” of the company was well established in the case of Salomon v. Salomon (1897), which will be discussed later.
  2. ARTIFICIAL PERSON – Similar to what has been defined above, a company is an artificial person, it is it’s personal and does not depend on its member. The company enjoys all the legal rights of a natural person. But it is not a natural person and is still an artificial person and needs representation.
  3. PERPETUAL SUCCESSION A company being an artificial person is not dependent on its members to survive. The death, insolvency, or transfer of shares of members does not, in any way, affect the existence of a company. It is a legal person having come into being by law, and only law can bring its end and none else. According to F. Pollock, a company’s perpetuity is like the river Thames. The river Thames is still the same though the parts which compose it are changing every instant.  The company will have a continuity in existence irrespective of any change in the membership of that company. The members may come and go but the company can go on forever until dissolved by the process of law.
  4. COMMON SEAL –A company has its own identity as an artificial person; hence it has its signature. Any document bearing the common seal of the company will be legally binding on the company.
  5. LIMITED LIABILITY A company cannot be held liable for more than what its limit is that is to say that a creditor cannot claim more than the liability of a company and its members. A member will only be liable for what they have subscribed for. If a company registered with limited liability, the liability of the member will be only to the extent of the face value of the share which is held by them or the amount guaranteed by them
  6. TRANSFERABILITY OF SHARES –0Only with certain restrictions, a person/member/shareholder is entitled to transfer the securities held by them to another person.

Doctrine of Lifting the Corporate Veil

A company does not represent its members but is a separate legal entity separate from its members.The fact that a company is a separate legal entity has been well established in the case of Solomon v. Solomon, this principle may be called the “veil of incorporation”.

This principle has the effect of having a fictitious veil between the corporation and its members. Thus, the liability of the members gets reduced in case of some misconduct. This is a company is its legal personality and can conduct business in its name. Subsequently, it will be sued and can sue in its name. This limits the liability of its members to the face value of the share s they have in the company.

The separate legal entity of the company has its advantages. The human ingenuity started to use the veil of corporate personality as a shield for committing fraud. The veil of the corporation may be used for defrauding shareholders, creditors, and even the government. The courts were compelled to break through or lift the corporate veil to find out the real beneficiary behind the company. 

The courts in such a situation ignore the separate legal entity of the company and punish the persons who have misused the company’s name. for this purpose, the doctrine of lifting the corporate veil or breaking the wall of the corporation is evolved by the courts. By pulling off the mask the court can verify who underneath is liable.

Protection of Revenue

If the sole objective or an ulterior motive of the corporation is to be used as an entity for tax evasion, the courts may ignore the corporate entity of the company. If a company is used to side-step tax duty, the legal and separate entity of a company will be overlooked.

Prevention of Fraud or Improper Conduct

The legal personality of the company may be overlooked by the court in the pursuit of justice. If theincorporation of the company is used for some illicit activities or fraud purposes like defrauding creditors or avoiding the specific performance of a contract or defeating law the court will lift the veil.

Determination of the Character of the Company

To determine the character of the company i.e. whether it is enemy or not, the court may lift the corporate veil.

Salomon v. A Salomon And Co Ltd [1897] Ac 22

Section 9 of the Indian Companies Act, 2013 has an effect of making the association a legal entity. It is a separate entity from its shareholders/members. The company decides its name and seal. The assets of the company are held by the company and are separate from its member’s assets. The “separate legal personality” of the company was well established in the case of Salomon v. Salomon (1897)

Facts

  1. Salomon was a shoe manufacturer. He registered a company namely Salomon and Co. Ltd with a total share capital of 30,000 pounds.
  2.  His wife and five children took up one share of one pound each. Salomon took 20,000 shares of one pound and 10,000 pounds debentures.
  3. The debentures gave to Salomon a charge over the assets of the company. The company went into liquidation within a year due to the general trade depression.
  4. It was alleged by the unsecured creditors that the company formed was a sham/shell company for defrauding purposes and that the company was functioning as an agent of Salomon. These claims were made by the liquidator who represented the unsecured creditors and made a claim that Salomon being the principle, was liable for the debts incurred by the company.

Issue

  1. The issue was whether the company that was serving as an agent to Salomon and incurring debts was a sham. And if it was a sham would Salomon be made liable for the debts incurred by the sham company.
  2. The second issue was whether, despite the company being its separate legal entity, could have an effect of transferring its liabilities onto the shareholders in certain cases of malfeasance by the said shareholder via the company name. And whether the corporate veil could be lifted to make the shareholders liable.

Judgement

  1. Upon hearing the case, the court of appeal held that the company was a myth and a sham made for defrauding purposes.
  2. The court held that since Salomon was using the sham company as an agent to sham and defraud the creditors, the former should be made liable for the debts incurred by the latter.
  3. The House of Lords, however, upon appeal, had reversed the decision of the court of appeals and through a unanimous decision held that the company was rightfully incorporated and had its rights and liabilities.
  4. That “the motives of those who took part in the promotion of the company are absolutely irrelevant in discussing what those rights and liabilities are”.[3] Thus, the legal fiction of “corporate veil” between the company and its owners/controllers[4]was firmly created by the Salomon case.

Analysis

  1. Salomon v. Salomon case is to date a case that is predominantly used to define a company and its characteristics. It ultimately left the question of lifting the corporate veil on the courts and held that sham, fraud, etc were all reasons to lift the veil of a corporation but were not exhaustive and thus the discretion is upon the courts to lift the corporate veil on case to case basis. 
  2. The judgment did a great job of explaining the jurisprudence of a company and its establishment at that time. The judgment established the character of a company being a separate legal entity.
  3. The court has adequately justified its reason with the proper interpretation of the law. The decision was a landmark judgment helping in the lifting of the corporate veil and piercing through the identity of a company that is protected via its status as a separate legal entity.

Conclusion

The jurisprudence behind these concepts is forever evolving and the fact that there exists a separate juristic body composed of individual juristic persons is a complex concept. Subsequent developments have led to the simplification of the concepts and have helped in deciphering the true nature of a corporation. It fascinating that even when members can all leave and entirely new people join in, a company retains its identity and thus it perpetually being succeeds on its own.

Also read Company Secretary-A Step Up To Managing Director?


[1]1963 AIR 1811; 1964 SCR (4) 89.

[2] The judgment referred to the State of Bombay, v. R.M.D. Chamar baugwala, I.L.R. [1955] Bom. 680; also see Tamlin v. Hannaford, L.R. (1950) 1 K. B. 18, which was referred to in Bank Voor Handel En Scheepvaart N. V. v. Administrator. of Hungarian Property, L.R. (1954) A.C. 584.

[3] Gas Lighting Improvement Co. Ltd. v Commissioners of Inland Revenue, 1923 AC 723;

[4] Jennings v Crown Prosecution Service, 2008 UKHL 29.

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