Theories of Corporate Personality

Theories of Corporate Personality MANAS AGARWAL 5th Semester BA LL. B (B) School of Law Christ University Bangalore INDEX * Research Methodology * Introduction * The Common Law Perspectives * Fiction Theory * Concession Theory * The Purpose Theory * Bracket Theory * Realist Theory * Why Corporations? * Corporate Personality And Limited Liability Cases: * Macaura v. Northern Assurance Co. * Lee v. Lee’s Air Farming * Salomon v. Salomon & Co. ACKNOWLEDGEMENT I Manas Agarwal of B. A. LL. B (Hons. ) is really grateful to Ms. Fincy V, without whose help and corporation this project would not have been possible.I am also grateful to the National Law School India University (N. L. S. I. U) Library staff and the Knowledge Centre, Christ University staff, whose cooperation is appreciable. I think this kind of assignments lead to the overall development of the students and I am looking forward to take up such assignments in future. RESEARCH METHODOLOGY †¢ SCOPE AND FOCUS: – This research paper essentially seeks to study and criticise the different theories of corporate personality considering the jurisprudential conflicts. †¢ RESEARCH OBJECTIVES: – The principal objective of our research is to study and criticise the different theories of corporate personality and the concepts under it. * Another objective of our research is to find conflicts between the various theories relying on various judgments. †¢ RESEARCH QUESTIONS: – * What is the difference between various theories of corporate personalities. * The meaning and limits of a corporate personality. †¢ METHOD OF ANALYSIS: – This project has its basis on the following methods of analysis:- DESCRIPTIVE: – The first task is to comprehensively study and critize the jurisprudential theories of corporate personalities.ANALYTICAL: – Further these concepts and observations can be analyzed. The valuable knowledge that is gained from studying the commentaries must be used to understand the evolution of the theories and the law itself in terms of some cases. †¢ MODE OF CITATION :- The researcher(s) has used a uniform mode of citation in this paper. Introduction There is an interesting conflict between philosophic theories as to the nature of corporate personality and the insurgent demand of economic forces for a further recognition of those form of organisation which seem so essential to modern life.The grant of legal personality is clearly within the gift of the state, for it may be refused to natural persons. In the case of natural person, however, it is clear that law grants legal personality to a physical entity existing in space and possessing what (for lack of better term) we describe as human personality. While philosophy may find difficulty in analyzing or describing the real nature of human personality, few of us doubt that we exist, and we compensate for our defective analysis by an intuitive understanding of our own natur e which, however inadequate it may be, at least gives a substratum on which to build.As far as legal personality is concerned, there is no very significant difference between that granted to human beings and that to non-human beings such as groups or other entity. The decision of House of Lords in Salomon v A Salomon & Co. Ltd had a lasting influence in corporation law. It is often credited with the principle of separate legal entity of the corporation distinct from the members. Though there is no doubt that the Salomon case had play a significant role in company law, the decision in this case was hardly the origin of the separate legal entity principle.The legal entity of beings other than the human has long been recognized prior to 1897, in which the Salomon case was decided. The jurisprudence theories on juristic person had been established since the early Roman law to justify the existence of legal person other than the human. The State, religious bodies and education institutio ns had long been recognized as having legal entity distinct from the members. The acceptance of the corporate personality of a company basically means that another non-human entity is recognized to assume a legal entity. This can be seen from the many theories of jurisprudence on corporate personality.Majority of the principal jurisprudence theories on corporate personality contended that the legal entity of the corporation is artificial. The fiction, concession, symbolist and purpose theories supported the contention that existence of corporation as a legal person is not real. It only exists because the law of the state recognized it as legal person and it is recognized either for certain purpose or objectives. The fiction theory, for example, clearly stated that the existence of corporation as a legal person is purely fiction and that the rights attached to it totally depend on how much the law imputes upon it by fiction.The Common Law Perspectives Generally, there are two types o f person which the law recognized, namely the natural and artificial person. The former is confined merely for human beings while the latter is generally referred to any being other than human being which the law recognized as having duties and rights . One of the most recognized artificial persons is the corporation. Legal scholars, particularly the jurists, have always explored the issue on the recognition of corporation as a legal person.In the study of jurisprudence, the separate legal personality of corporation is based upon theories, which are concentrated upon the philosophical explanation of the existence of personality in beings other than human individuals. W. Friedman stated that: â€Å"All law exists for the sake of liberty inherent in each individual; therefore the original concept of personality must coincide with the idea of man. † Even though there are many theories which attempted to explain the nature of corporate personality, none of them is said to be domi nant.It is claimed that while each theory contains elements of truth, none can by itself sufficiently interpret the phenomenon of juristic person. Nonetheless, there are five principal theories, which are used to explain corporate personality, namely, the fiction theory, realist theory, the purpose theory, the bracket theory and the concession theory. Fiction Theory The fiction theory holds that corporations are simply legal fictions, created and sustained by an act of the state. They are endowed with corporate personality simply because this is a convenient form through which the natural persons behind the corporation may conduct their business.According to this theory, the legal personality of entities other than human beings is the result of a fiction. Hence, not being a human being, corporation cannot be a real person and cannot have any personality on its own. Originally, the outward form that corporate bodies are fictitious personality was directed at ecclesiastic bodies. The doctrine was used to explain that the ecclesiastic colleges or universities could not be excommunicated or be guilty of a delict as they have neither a body nor a will. The famous case of Salomon v A Salomon Co Ltd is a proof of the English court adoption of the fiction theory.In this case, Lord Halsbury stated that the important question to decide was whether in truth an artificial creation of the legislature had been validly constituted. It was held that as the company had fulfilled requirements of the Companies Act, the company becomes a person at law, independent and distinct from its members. Despite its instrumental conception of the corporation, the fiction theory still affords a sufficient basis for according corporations legal rights. Indeed, it is on the basis of the fiction that corporations are persons that they possess the legal rights they do, such as private property rights.However the fiction theory affords no basis for the recognition of moral rights of corporations . On the fiction view, â€Å"corporations, as creatures of the State, have only those rights granted them by the State. † The personality the corporation enjoys is not inherent in it but as conceded by the state. Due to the close connection made in this theory as regards to relation of legal personality and the power of the state, fiction theory was claimed to be similar to the theory of sovereignty of state which is also known as the concession theory. Concession TheoryA group of persons wanting to create a corporation will have to execute documents and comply with requirements set by the state before being given corporate personality; merely a privilege; state may provide causes for which the privilege may be withdrawn. It maintains that the law is the only source from which the legal personality may flow. The law lays down certain conditions which creates the legal personality of a corporation. Corporate form is therefore a concession given by the state. The concession the ory is basically linked with the philosophy of the sovereign national state.It is said to be essentially a product of the rise of the national state at a time when there were rivals between religious congregations and organizations of feudal origin for the claim of national state to complete sovereignty. Under the concession theory, the state is considered to be in the same level as the human being and as such, it can confer on or withdraw legal personality from other groups and associations within its jurisdictions as an attribute of its sovereignty. Hence, a juristic person is merely a concession or creation of the state.Concession theory is often regarded as the offspring of the fiction theory as it has similar claim that the corporations within the state have no legal personality except as it is conceded by the state. Exponents of the fiction theory, for example, Savigny, Dicey and Salmond are found to support this theory. Nonetheless, it is that while the fiction theory is ulti mately a philosophical theory that a corporation is merely a name and a thing of the intellect, the concession theory is indifferent as regards to the question of the reality of a corporation in that it focuses on the sources of which the legal power is derived.Dicey took the view that sovereignty is merely a legal conception which indicates the law-making power unrestricted by any legal limits. The Purpose Theory This theory is also known as the theory of Zweckvermogen. Similar to the fiction and concession theories, it declares that only human beings can be a person and have rights. Entities other human is regarded as an artificial person and merely function as a legal device for protecting or giving effect to some real purpose. As corporations are not human, they can merely be regarded as juristic or artificial person.Under this theory, juristic person is no person at all but merely as a â€Å"subject less† property destined for a particular purpose and that there is owner ship but no owner. The juristic person is not constructed round a group of person but based on the object and purpose. The property of the juristic person does not belong to anybody but it may be dedicated and legally bound by certain objects. This theory rationalized the existence of many charitable corporations or organizations, such as trade unions, which have been recognized as legal persons for certain purposes and have continuing fund.It is also closely linked with the legal system which regard the institution of public law and the endowment of private law as legal personalities. Bracket Theory According this theory, a company consisting of its members or shareholders exists and it is inconvenient to refer always to all of them, a bracket is placed around them to which a name is given but in order to understand the real position we must remove the bracket. The real status is given in realist theory. Realist Theory On the realist view, the corporation is more than a legal ficti on, and more than simply an agreement between its shareholders.It is an autonomous institution with a demonstrable extra-legal existence, analogous in some respects to a self-governing state. Like the contract theory, the realist theory recognises that the shareholders of a corporation delegate the powers of control over their property to the corporation's management so that the property can be pooled towards a unified purpose. Unlike under the contract theory, however, the shareholders are seen more as investors in the corporation than owners of it.This is why managers owe fiduciary duties not simply to the shareholders, but to the corporate person as a whole. Of the three theories, only the realist theory seems capable in principle of supporting moral rights for corporations, because only it grants them a real social existence apart from the concession of the state or the agreement of their shareholders. However it seems that the realist theory of corporate personality has fallen out of favour amongst modern academic writers. This may be because it seems to accurately describe only a limited subset of corporations.Many types of corporations which have assumed greater importance since the realist view gained prominence, including holding companies and trustee companies, sit uneasily within the realist framework. Nevertheless it is believed that the realist theory is potentially the most useful of the three set out above, so long as the subset of corporations to which it most accurately applies can be sufficiently delineated. By itself the theory seems incapable of providing any basis for such delineation. If the realist conception of the corporation is to be salvaged at all, its assumptions must be explicated by some other theory.Why Corporations? The above survey of the theories of corporate personality has revealed no complete conception of the corporation which justifies the recognition of moral rights of corporate persons. To some extent, this is hardly s urprising. Corporate personality is a legal concept based on purely commercial considerations: The concept of the juridical person is convenient to the conduct of business by providing for extended â€Å"life† and a limitation on liability, not to mention the right to own property and enter into contracts, which the law reserves to people.But laws might be fashioned to give corporations the same power to own property and sign valid contracts without terming them persons. There is therefore no reason why the types of bodies (if any) which deserve to be endowed with collective rights should coincide with those organisations allotted the status of persons by the law for purely instrumental reasons. For instance, corporations are classified as legal persons, but partnerships are not. Yet there is no obvious reason why the mere act of incorporation by a partnership should endow it with moral rights which it did not possess before.The intuition which many lawyers seem to possess th at corporations do possess rights can be explained as a psychological response to the â€Å"unified normative vocabulary† with which natural and corporate persons are described. That is, the personification of the corporation leads lawyers to indiscriminately apply concepts to it which are rightly applicable only to natural persons. However although this may be a convenient mode of analysis, it is clearly not conceptually consistent for rights to be accorded to bodies corporate (and to no other collectivities) purely because they bear that designation.Nevertheless, that is precisely what propose should be done. The rationale is that the present paper is not simply a normative, but also a descriptive study. It is apparent that corporate persons are already recognised as more appropriate bearers of rights than non-incorporated bodies under Australian law. It is for this reason that they have property and other common law rights which non-incorporated bodies lack. It is likely, therefore, that any extension of the rights recognised of collectivities under our law will employ this existing category.To extend the recognition of rights to non-incorporated bodies would require the recognition of a third type of personhood hitherto unknown to the law. However desirable this may be, it is not a realistic proposal for law reform. Corporate Personality And Limited Liability Corporate personality refers to the fact that as far as the law is concerned a company personality really exists apart and different from its owners. As a result of this, a company can sue and be sued in its own name, hold its own property and crucially – be liable for its own debts.It is this concept that enables limited liability for shareholders to occur as the debts belong to the legal entity of the company and not to the shareholders in that company. Corporate legal personality arose from the activities of organisations such as religious orders and local authorities which were grant ed rights by the government to hold property and sue and be sued in their own right and not to have to rely on the rights of the members behind the organisation. Over time the concept began to be applied to commercial ventures with a public interest element such as rail building ventures and colonial trading businesses.However, modern company law only began in the mid-nineteenth century when a series of Companies Acts were passed which allowed ordinary individuals to form registered companies with limited liability. The way in which corporate personality and limited liability link together is best expressed by examining the key cases:- Salomon v Salomon ; Co. Mr Salomon carried on a business as a leather merchant. In 1892 he formed the company Salomon ; Co. Ltd. Mr Salomon, his wife and five of his children held one share each in the company.The members of the family held the shares for Mr Salomon because the Companies Acts required at that time that there be seven shareholders. Mr Salomon was also the Managing Director of the company. The newly incorporated company purchased the soletrading leather business. The leather business was valued by MrSalomon at ? 39,000. This was not an attempt at a fair valuation; rather it represented Mr Salomon’s confidence in the continued success of the business. The price was paid in ? 0,000 worth of debentures (a debenture is a written acknowledgement of debt like a mortgage – see Chapter 7) giving a charge over all the company’s assets (this means the debt is secured over the company’s assets and Mr Salomon could, if he is not repaid his debt, take the company’s assets and sell them to get his money back), plus ? 20,000 in ? 1 shares and ? 9,000 cash. Mr Salomon also at this point paid off all the sole trading business creditors in full. Mr Salomon thus held 20,001 shares in the company, with his family holding the six remaining shares. He was also, because of the debenture, a secured cred itor.However, things did not go well for the leather business and within a year Mr Salomon had to sell his debenture to save the business. This did not have the desired effect and the company was placed in insolvent liquidation (i. e. it had too little money to pay its debts) and a liquidator was appointed (a court appointed official who sells off the remaining assets and distributes the proceeds to those who are owed money by the company, see Chapter 16). The liquidator alleged that the company was but a sham and a mere ‘alias’ or agent for Mr Salomon and that Mr Salomon was therefore personally liable for the debts of the company.The Court of Appeal agreed, finding that the shareholders had to be a bona fide association who intended to go into business and not just hold shares to comply with the Companies Acts. The House of Lords disagreed and found that- the fact that some of the shareholders are only holding shares as a technicality was irrelevant; the registration procedure could be used by an individual to carry on what was in effect aone-man business a company formed in compliance with the regulations of the Companies Acts is a separate person and not the agent or trustee of its controller.As a result, the debts of the company were its own and not those of the members. The members’ liability was limited to the amount prescribed in the Companies Act – i. e. the amount they invested. The decision also confirmed that the use of debentures instead of shares can further protect investors. Macaura v Northern Assurance Co. Mr Macaura owned an estate and some timber. He agreed to sell all the timber on the estate in return for the entire issued share capital of Irish Canadian Saw Mills Ltd.The timber, which amounted to almost the entire assets of the company, wasthen stored on the estate. On 6 February 1922 Mr Macaura insured the timber in his own name. Two weeks later a fire destroyed allthe timber on the estate. Mr Macaura tried to claim under theinsurance policy. The insurance company refused to pay outarguing that he had no insurable interest in the timber as the timber belonged to the company. Allegations of fraud were also made against Mr Macaura but never proven. Eventually in 1925 theissue arrived before the House of Lords who found that:The timber belonged to the company and not Mr Macaura Mr Macaura, even though he owned all the shares in the company, had no insurable interest in the property of the company just as corporate personality facilitates limited liability by having the debts belong to the corporation and not the members, it also means that the company’s assets belong to it and not to the shareholders. More modern examples of the Salomon principle and the Macaura problem can be seen in cases such as Barings Plc (In Liquidation) v Coopers ; Lybrand (No. 4) [2002] 2 BCLC 364.In that case a loss suffered by a parent company as a result of a loss at its subsidiary (a company in which it he ld all the shares) was not actionable by the parent – the subsidiary was the proper plaintiff. In essence you can’t have it both ways – limited liability has huge advantages for shareholders but it also means that the company is a separate legal entity with its own property, rights and obligations. Lee v Lee’s Air Farming Mr Lee incorporated a company, Lee’s Air Farming Limited, in August 1954 in which he owned all the shares. Mr Lee was also the sole ‘Governing Director’ for life.Thus, as with Mr Salomon, he was in essence a sole trader who now operated through a corporation. Mr Lee was also employed as chief pilot of the company. In March 1956, while Mr Lee was working, the company plane he was flying stalled and crashed. Mr Lee was killed in the crash leaving a widow and four infant children. The company as part of its statutory obligations had been paying an insurance policy to cover claims brought under the Workers’ Compens ation Act. The widow claimed she was entitled to compensation under the Act as the widow of a ‘worker’.The issue went first to the New Zealand Court of Appeal who found that he was not a ‘worker’ within the meaning of the Act and so no compensation was payable. The case was appealed to the Privy Council in London. They found that: the company and Mr Lee were distinct legal entities and therefore capable of entering into legal relations with one another as such they had entered into a contractual relationship for him to be employed as the chief pilot of the company he could in his role of Governing Director give himself order as chief pilot.It was therefore a master and servant relationship and as such he fitted the definition of ‘worker’ under the Act. The widow was therefore entitled to compensation. Separate legal personality and limited liability are not the same thing. Limited liability is the logical consequence of the existence of a separ ate personality. The legal existence of a company (corporation) means it can be responsible for its own debts. The shareholders will lose their initial investment in the company but they will not be responsible for the debts of the company.Just as humans can have restrictions imposed on their legal personality (as in the case of children) a company can have legal personality without limited liability if that is how it is conferred by the statute. CONCLUSION person is not artificial or fictitious but real and natural. The realist also contended that the From the discussion on jurisprudence theories of corporate personality by G. W Paton, it is observed that main arguments lie between the fiction and realist theories.The fiction theory claimed that the entity of corporation as a legal person is merely fictitious and only exist with the intendment of the law. On the other hand, from the realist point of view, the entity of the corporation as a legal law merely has the power to recogniz e a legal entity or refuse to recognize it but the law has no power to create an entity. Referring to the English company law case law, it can be seen that in most cases, the court adopted the fiction theory. Salomon v A Salomon Co Ltd is the most obvious example.It is also observed that fiction theory provide the most acceptable reasoning in justifying the circumstances whereby court lifted the corporate veil of corporation. If the entity of the corporation is real, then the court would not have the right to decide the circumstances where there is separate legal entity of the corporation should be set aside. No human being has the right to decide circumstances whereby the entity of another human being should be set aside. Only law has such privilege.Nonetheless, the realist contention that the corporation obtain its entity as a legal person not because the law granted it to them but because it is generated through its day to day transaction which are later accepted and recognized b y law also seem acceptable. Bibliography * A Text Book of Jurisprudence, 2nd Ed, by G. W. Paton * Corporate personality in the 20th century edited by Ross Grantham * Manupatra. com * Legalservicesindia. com * Westlaw. com ——————————————– [ 1 ]. Cf. A. Kocourek, Jural Relations (2nd ed. ), 57. [ 2 ]. Stokes, M. â€Å"Company Law and Legal Theory† in Twining, W. ed). Legal Theory and the Common Law. Basil Blackwell, Oxford, 1986, 155, 162. [ 3 ]. Salomon v A Salomon & Co Ltd [1897] AC 22 [ 4 ]. First National Bank v Bellotti (1978) 435 US 765 [ 5 ]. Mark, G. Op. cit. 1472. [ 6 ]. cf. Mills v Mills (1938) 60 CLR 150 [ 7 ]. Woytash, J. â€Å"We Must Stop Viewing Corporations as People† (1978) 64 ABAJ 814 [ 8 ]. Dan-Cohen, M. Rights, Persons, and Organizations. University of California Press, Berkeley, 1986, 5. [ 9 ]. Salomon v Salomon & Co. [1897] AC 22 [ 10 ]. Macaura v Northern Assurance Co. [1925] AC 619 [ 11 ]. Lee v Lee’s Air Farming [1961] AC 12