Corporate personality is the creation of law. And as per the law, a corporation is an artificial person created by the personification of a group of individuals. The theory of corporate personality mainly states that a company has a legal identity different from its member. Both English and Indian laws follow the concept of corporate personality.
The creditors of the company can recover their money only from the company and they cannot sue individual members. In the same way, the company is not in any way liable for the individual debts of its shareholders/members and the property of the company is only used for the benefit of the company.
It enjoys certain rights and duties such as the right to hold property, right to enter into contracts, to sue and be sued in the name of the company. The rights and liabilities of the members are different from the company.
In short, corporate/legal personality, which the company acquires on incorporation, confers legal personality and independent status to the company.
There are two types of corporations:
For the first time, this concept was recognized in the year 1867 in the case of Oakes v. Turquand and Harding. But it was approved and firmly established in the leading case of Salomon vs. Salomon in which it was held that a company has its own personality which is different from the personalities of the individuals.
CASE STUDY: Salomon v A Salomon & Co Ltd  AC 22
- Mr. Aron Salomon was a businessman who specialized in manufacturing leather boots. After a few years, he incorporated a limited company known as Salomon and Co. Ltd.
- In order to meet the requirement to incorporate a company, he needed at least seven members/ shareholders so he decided to make his family members his business partners by giving one share to each of them.
- He sold his business to the limited company for $39000 out of which $10000 was a debt to him. He was then the company’s principal shareholder and principal creditor.
- After one year, the company went into liquidation. The assets realized were $6000 while the liability was debentures held by Salomon $10000 and unsecured creditor $7000.
- An unsecured creditor challenged the right of Salomon to have preference as debenture holder over unsecured creditors.
Was the formation of Salomon’s company a fraud intended to defraud the creditors?
The court said that on incorporation, the company became an independent legal person and not an agent of Salomon. Salomon, as a debenture holder of the company was ought to get priority in payment over the unsecured creditor.
IMPORTANCE OF THIS JUDGEMENT:
The decision in this case established the concept of separate legal personality of a company which allowed shareholders to carry on trading with minimal exposure to the risk of personal insolvency in the event of a collapse. There are 2 principles laid down in the Salomon’s case:
- Artificial Person: Company is an artificial person created by law. Artificial in the sense, it has no body/soul like a natural person. Created by law means formation of a company requires fulfilment of so many legal formalities.
- Limited Liability: The liability of the members is limited to the extent of the face value of the shares, where the company is limited by shares. Then, the shareholder is liable to the extent of the unpaid capital on his shares and his personal assets will not be affected in the event of winding up of the company.
CASE STUDY: Lee v. Lee’s Air Farming Ltd. (1961) AC 12
- This case is concerning about the veil of incorporation and separate legal personality. In this case out of the 3000 shares in Lee’s Air Farming Ltd., L held 2999 shares. He made himself the Managing Director and was also the chief pilot on a salary.
- While working for the company he was killed in an air crash. Since his death was in the course of employment, his widow claimed for compensation. She claimed £2,430 compensation for herself and her four infant children and she also claimed a sum for funeral expenses.
- The respondent company denied that deceased was a “worker” of the company and alleged that at the time of the accident the deceased was the controlling shareholder and governing director of the respondent company.
Was there a separate legal entity? Whether Mrs. Lee can claim compensation?
The Lee Air Farming case confirmed the Salomon principal. The Privy Council allowed Mrs Lee’s claim and said that Lee might have been the controller of the company in fact but in law, they were separate distinct persons and the concept of separate legal entity was explained. Mr. Lee could therefore enter into a contract with the company, and could be considered to be an employee. His wife was therefore entitled to an award in respect of workmen’s compensation.
Judicial Committee of the Privy Council also said that a company is a separate legal entity, so that a director could still be under a contract of employment with the company he solely owned.