The Doctrine of Limited Liability - Assignment Example

Corporations Law Student’s Name Institutional Affiliation Question 1 Issue In this case, the legal issue is to determine whether Simon, who is the majority shareholder and managing director of the Slowgo Pty Ltd, is severally and personally liable for the debt incurred while the company was in state of insolvency. The company has few assets which cannot cover the debt owed to creditors. Law The separate entity doctrine holds that when an incorporated company becomes a legal person separate and distinct from its shareholders and managers. Therefore, the law states that the company becomes a body corporate with an autonomous legal existence with the capacity to sue or be sued, and with limited liability1. In the underlying doctrine of limited liability, a shareholder member is not required to contribute to help the company settle its debts, beyond the amount originally subscribed for the shares. This doctrine is much reflected in the Corporate Act section (9) in the definition of the ‘company limited by shares2.’ As a result the members who have fully paid shares are not required to contribute extra amount to assist the company cover its debts3. Salmon v Salmon case and company liability The principle of legal personality was originally formulated by the House of Lords in the United Kingdom, in the very much known case of Salomon v Salomon and Company limited where Lord Macnaghten was categorical that the limited company is a different person from the people subscribed to the memorandum4. The principle of separate legal persons is contained in the Company’s Act of Section 16 (1) and provides inter alia that the subscribers along with other persons may become company members who are a corporate body as contained in the memorandum; possess power of performing functions and activities of an incorporated company; hold perpetual succession, and a common seal, from the time and date of incorporating a company5. Therefore, the decisions and resolutions made in the Salmon v Salmon’s case are based on certain principles as described below: That the company even so called one man company is a legal person separate and distinct from managers and shareholders. That incorporation was also possible for the sole proprietorships and partnerships. The members can also subscribe to the debentures. Lifting the veil of incorporation In exceptional situations, the court is may be willing to lift the veil of incorporation by treating company’s deeds as responsibility or belonging to another6. In certain situations, the Corporate Act is capable of piercing or lifting the veil of incorporation where the company in question is suspected to have been transacting while insolvent7. Piercing or lifting the veil of incorporation, the court is willing and able to make certain people severally and personally liable for the company’s debt or responsible for bringing back the company’s situation it would have been if the insolvency did not occur8. Under section 588G of the Company’s Act, directors can be made liable because of failing to prevent the company9. The liability may occur where a person is a director at the time when the company incurs debts and at the same time is insolvent, and there were considerable grounds for detecting that the company would become insolvent, and the director is aware of the fact, the director contravenes the Company’s Act if he fails to prevent the company from incurring the debt10. If there is no statutory defence to the liability, the court orders the director to pay for the debt equal to the damage caused to the creditors. Additionally, the directors of the companies can be held liable if the court lifts the corporate veil on the bases that the company was established to default the creditors11. Application Simon as the majority shareholder and managing director was protected from the company’s debts due to the fact that limited companies are the legal or artificial person distinct and separate from its members and manager, as portrayed in the principles of Salmon v Salmon case and company liability12. However, Simon as a managing director continued to trade while he knew the company was in the state of solvency. The situation is supported by the inability of the company’s assets not enough to settle creditor's debt, while himself could have prevented incurring of debt with more value than the company’s assets13. Therefore, the court will pierce the veil of incorporation (penetrate the shielding screen between members and company) to make the Simon liable or responsible for bringing back or restoring the company’s position it was before insolvency. Additionally, the court may also look beyond the façade through which Simon established Slowgo Pty Ltd, whether there was the intention to default the said creditor. If Simon did not have the statutory defence, the court would order Simon to pay $500,000 to a creditor on behalf of the company. Conclusion Simon was made severally and personally liable for the debt of the company through the court’s power to lift or pierce the veil of incorporation due to continued trading even when the company was insolvency. Question 2 Introduction A company is an artificial person distinct and separate from its owners and the directors. Therefore, this implies that the company’s directors, as well as the shareholders are usually not liable for the company debts. However, exceptions to the general rule that states that directors are not personally responsible for the company debts are found on the guidelines pertaining to insolvency trading as stipulated by the Corporations Act 2001 (Cth)14. In general, insolvency trading entails incurring debts at the moment when there is a reasonable basis to believe that the company is unable or is likely to be incapable of paying its debts. The Australian Securities and Investment Commission (ASIC) is mandated to regulate companies within the country. The main objective of ASIC is to ensure consumer and business protection while dealing with the companies and to make sure that companies follow the law, provide reports for their activities and keep proper records15. Most companies can be categorized into two based on the liability imposed on the shareholders of the company. Thus, they are either; Companies limited by shares This type of the company restricts the shareholders’ liability to the price of their shares. This form is appropriate for most business entities. Companies limited by shares can either fall into the category of public or private company; or Companies limited by guarantee; In most cases, they are formed by non-profit making organizations like charitable organizations and sporting clubs. Companies limited by shares Public Company This is a type of the company where the public is the majority shareholders. A public company must include at least one shareholder with no maximum number of the shareholders. Similarly, there are no limits to the extent to which the public company may raise funds from the members of the public. The shareholders’ liability in the public company is restricted to share balance. Additionally, a public company’s name must end with the word limited or “Ltd16." Private Company This is the type of the company where transferability of shares is limited to the public. The sales of shares in a private company is normally restricted in one way or another, such as the provisions that the company directors need to approve any shares transfer. Similarly, new shareholders in a private company can only become members prior to the registration of shares transfers to them by the company. A private company has a minimum membership of one and utmost of fifty17. The members' liability is restricted to the unpaid amount, if any, owing on the members’ shares. A private company’s name must end with the words “Pty Limited” Company limited by guarantee A guarantee limited company is described as the one that members’ liability is limited to the individual members’ contributions to the company’s property in the circumstances where the company is dissolved. The guarantee limited companies must not carry any business with the aim of making profits. Therefore, they are appropriate for non-profit making entities such as charitable and religious organizations18. Companies Limited by Shares and by Guarantee Some companies may be limited both by guarantee, as well as by the shares. However, these types of companies are not common in Australia. Other Companies No Liability Company This type of company may only be formed for the purposes of mining. Although this type of a company has share capital, it does not have contractual rights set by its framework to recover calls from its shareholders made on shares in the circumstances where they do not honour the payment19. Unlimited Company An unlimited company refers to the company that has unlimited liability operated as a partnership but through the framework of a corporate body. Foreign Company A foreign company refers to an entity whose incorporation is based on external territory (outside Australia). Conclusion Based on the case study where Ace, Brenda, Chris and Deidre who own a large shoe retailing business and they wish to raise capital through the sale of shares of shares I would advise them to form a public liability company. The advantage of forming public company instead of a private company is that they are able to raise the amount of required capital through the sale of shares to the members of the public. Through the sale of shares, they will be able raise enough capital for the growth and sustainability of the company. Similarly, public companies have no limited membership giving the company an opportunity for future growth. Additionally, if they choose to establish a public company, they will create a form of currency inform of its stocks that can be used by the company to make acquisitions. Also, the company may have high chances of accessibility to capital markets in case of future financial needs. References Primary Sources Cases Salmon v Salmon and company limited Legislations Corporations Act 2001 (Cth) Secondary Sources Books Brough, G. H. (2005). Private limited companies: Formation and management. Edinburgh: Thomson/W. Green. Hannigan, B. (2012). Company law. Oxford, U. K: Oxford University Press Hanrahan, P., Ramsay, I. & Stapledon, G. (2014). Commercial Applications of Company Law, 15th ed., CCH. Rudorfer, M. (2009). Piercing the Corporate Veil: A Sound Concept. München: GRIN Verlag GmbH. Wood, R. W. (2001). Limited liability companies: Formation, operation, and conversion. New York: Aspen Publishers. Read More