Seminar 4

Corporate Personality and Nature of the Limited Liability Company

Doctrine of Corporate Personality

A company is a legal entity different and distinct from its members, i.e., an incorporated company is a
legal entity separate from its shareholders and has an independent legal existence or corporate status,
unlike a partnership or sole proprietorship. For example, if X Ltd borrows $2 million from Y Bank but
fails to repay the sum owed, Y bank can only sue X Ltd and not the shareholders of X Ltd for repayment.

⼆二
The shareholders are separate from the company and enjoy the protection of ‘limited liability’. Their
liability is limited to their respective shareholding or investment that they put into X Ltd. In the event that
X Ltd fails as a business, the shareholders will lose their capital investment, but they are not personally
-
liable for the debts of X Ltd. Note: The concept of limited liability only applies to the shareholders. The
liability of the company itself is unlimited.

Let us contrast this with a sole proprietorship. Dave runs his furniture making business as a sole proprietor
under the name of ‘Dave Furniture Factory’. He places orders with a supplier for leather worth $500,000
on credit. If he fails to pay for the leather at the end of the credit period, the suppliers can sue him for
breach of contract. Dave will be fully responsible for the debts incurred by Dave Furniture Factory, as
Dave and Dave Furniture Factory are not separate legal entities. However, Dave will not incur any
personal liability if he uses a limited liability company.

Salomon v Salomon [1897] AC 22

Mr Salomon had carried on a boot- making business for several years under the name of ‘Salomon & Co’.
Later, he formed a registered limited liability company: Salomon & Co Ltd. He was the majority
shareholder with 20,001 in shares at £1 each; the other six shareholders (all members of his family) had one
share each. The managing director of Salomon & Co Ltd was Mr Salomon himself.

The company purchased the boot- making business from Mr Salomon. The price of the boot- making
business was £39,000, but the company had only £20,007. The company borrowed the difference (i.e.
£39,000 less £20,007) by entering into loan agreements. In particular, Mr Salomon lent the company
£10,000, by way of a ‘secured debenture’, which would give the ‘secured’ creditor a right to be paid before
other (unsecured) creditors in the event of the company going into ‘liquidation’.

Not long after the company was formed, there was a depression and it was liquidated. Its liabilities were
£18,000 (including the £10,000 owed to Mr. Salomon) whilst its assets were only £6,000. This amount was
paid to Mr Salomon as a secured creditor and the remaining creditors received nothing. These unsecured
creditors claimed that to all intents and purposes Mr Salomon was the company and so he could not owe
money to himself.

The House of Lords held that Mr Salomon and Salomon & Co Ltd were two separate and distinct persons.
Salomon was entitled to be paid before the unsecured creditors, as the company was duly registered and
was a separate legal entity. Salomon was able to contract with and be a secured creditor of the company.
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Note that there was no evidence that Mr Salomon had behaved fraudulently. Had he done so, the case
would have been decided differently.
⼀一

Lord Macnaughten explained: ‘The company is at law a different person altogether from the subscribers to
the memorandum; and although it may be that after incorporation the business is precisely the same as it
was before and the same persons are managers and the same hands receive the profits, the company is not
in law the agent of the subscribers or trustee for them. Nor are the subscribers as members liable, in any
shape or form, except to the extent and in the manner provided by the Ordinance.’

The principle of separate legal entity was applied in the following cases:

Macaura v Northern Assurance Ltd [1925] AC 619 HL, Macaura (M), owner of the Killymoon estate in
county Tyrone, sold the whole of the timber on the estate to a company, Irish Canadian Sawmills Ltd, in
consideration of the allotment to him of 42,000 fully paid £1 shares. M and his nominees held all the
company’s shares, and he was also an unsecured creditor of the company for £19,000. Subsequent to the
sale, he purchased insurance policies in his own name with the insurance respondent company and others,
covering the timber against fire. Two weeks later, almost all of the timber was destroyed in a fire. M
claimed on the insurance policies.

It was held that M had no insurable interest in the timber, as he and the company were separate legal
entities. His claim was disallowed because the timber was owned by the company.

‘… [N]o shareholder has any right to any item of property owned by the company, for he has no legal or
equitable interest therein. He is entitled to a share in the profits while the company continues to carry on
business and a share in the distribution of the surplus asset when the company is wound up…’ (per Lord
Buckmaster)

The principles established in Salomon have been applied to deal with the question of a person acting for and in
relation to a company in various capacities.

Lee v Lee's Air Farming [1961] AC 12, Lee formed a company and held 2,999 of the 3,000 shares. He was
appointed sole director under the Articles of Association and was employed as a salaried chief pilot. He was
later killed in an air crash. His wife tried to claim compensation under the Worker's Compensation Act for the
death of her husband, claiming that he was an employee. The issue was whether there was a relationship of
employee and employer between Mr Lee and his own company.

The court held that a company could make a valid and effective contract with its members. It was possible for
a person to be at the same time in total control of a company (as its principal shareholder and sole director) and
a servant employed by that company.

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Exceptions to the Doctrine—Lifting the Corporate Veil
The fact that the separate corporate personality of a company prevents outsiders from taking action against its
members has led to its comparison with a ‘veil’. However, the courts will not allow the separate legal entity
principle to be used (or, more accurately, abused) where it might be unjust. In other words, unscrupulous
business people may undertake dubious activities under the ‘veil’ of a limited company and seek to evade
liability in the event of business failure. There are situations where the law is prepared to ‘lift the veil’ of
incorporation to go behind the corporate personality to the individual members, and impose personal liability
on shareholders or directors. The courts acknowledge the possibility of abuse and will not allow a company or
its shareholders to claim the separate legal entity principle where the use of the corporate status is a sham.

A. Under the Common law

There are instances where the court disregarded the concept of separate legal entity and pierced the corporate
veil, finding individuals behind the company liable. However, there is no precise test or comprehensive list of
guidelines. The following are examples of decided cases:

(1) Fraudulent Purpose: where the company is formed principally as a sham to evade existing liability or
defeat the law.

In Gilford Motor Co v Horne [1933] Ch 935 , Horne had been employed as managing director of Gilford
Motor Co and had covenanted that after the termination of his employment he would not solicit his former
employer's customers. Soon after the termination of his employment he formed a new company in which his
wife and an employee were the sole shareholders to solicit customers of his former employer. It was held that
H and the company, as his agent and under his direction, had committed breaches of the covenant. The court
lifted the corporate veil, and granted an injunction against both H, the former employee, and his company,
even though the company was not a party to the covenant.

Jones v Lipman [1963] 1 WLR 832, Lipman entered into a contract to sell land to Jones, but subsequently
changed his mind. He attempted to defeat Jones' right to specific performance by selling the land to a
company formed by himself. The court made an order for specific performance against both L and his
company, holding that specific performance cannot be resisted by a vendor who has absolute ownership and
control of the company in which the land is vested. The court looked behind the corporate veil.

In HKSAR v Leung Yat Ming [1999] 2 HKLRD 402, Leung’s employer, the Chinese University, offered a rent
allowance to her on condition that the proposed accommodation was not owned by the employee, her spouse
or relatives and that neither the employee, his spouse or relatives had any financial interest in the property.
Leung’s husband purchased a shelf company (Marble Shine) which was owned and controlled through
nominee shareholders and directors. An apartment was purchased in the name of the company and Leung
claimed a rent allowance from the Chinese University. When she left the her employment, her husband
claimed a rent allowance from HK University. They were both convicted under s 9(3) of the Prevention of
Bribery Ordinance (Cap 201). On appeal they argued that they had not acted illegally and the corporate veil

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should not be lifted and that they had not acted illegally but were simply ordering their affairs. The Court of
Appeal held that where the justice of the case required, it was permissible to go behind the corporate veil,
particularly where it was a cloak for deception. Leung and her husband had a financial interest in the property
concerned and were not merely innocently ordering their affairs.

To lift or pierce the corporate veil, there must be clear evidence of fraud or cheating. It is legitimate to use a
limited liability company as a vehicle of business in order to minimize the risk of the business.

Compare:

In Bakri Bunder Trading Co Ltd v Neptune [1986] HKLR 345, X controlled 3 companies, each of which
owned a ship. The three ships were provided with supplies from the same creditor. Two of the ships ordered
supplies from the creditor and failed to pay the price after delivery. The creditor sued the 2 companies holding
those ships and obtained judgment, but was unable to enforce the judgment. The creditor then arrested the 3rd
ship to enforce judgment against the other 2 companies on the ground that all 3 companies were owned by X.
[Ask yourself: is the 3rd company involved? Is there any evidence of fraud?] The court refused to lift the veil
as it was not improper use of a separate corporate entity to take advantage of limited liability for each ship.
(one-ship company)

In China Ocean Shipping Co v Mitrans Shipping Co Ltd [1995] 3 HKC 123, Cosco chartered a ship to a
company called Mitrans Maritime Panama SA (MMP), to carry cargo from China to North Korea. A dispute
between Cosco and MMP was referred to arbitration. The arbitrators awarded that MMP pay Cosco more
than US$150,000. MMP failed to pay and Cosco claimed that MS were liable to pay because MS controlled
MMP and MMP was no more than a façade for MS to evade their legal obligations to Csoco. The Court of
Appeal held that it was MMP who had chartered the ship and that the claim against MS should fail. MS had
not evaded their legal obligations: they had simply used a corporate structure to avoid incurring obligations.
The corporate veil could not be lifted merely because the corporate structure was used to ensure that certain
liabilities fall on another company within the group.

Per Bokhary JA (at p 127): ‘Using a corporate structure to evade legal obligations is objectionable. The court’s
power to lift the corporate veil might be exercised to overcome such evasion so as to preserve legal obligations.
But using a corporate structure to avoid the incurring of any legal obligation in the first place was not
objectionable. And the court’s power to lift the corporate veil does not exist for the purpose of reversing such
avoidance so as to create legal obligations.’

Also compare: Adams v Cape Industries plc [1990] 1 Ch 433, at 544:

… we do not accept as a matter of law that the court is entitled to lift the corporate veil as against a defendant
company which is the member of a corporate group merely because the corporate structure has been used so
as to ensure that the legal liability (if any) in respect of particular future activities of the group (and
correspondingly the risk of enforcement of that liability) will fall on another member of the group rather than

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the defendant company. Whether or not this is desirable, the right to use a corporate structure in this manner is
inherent in our corporate law.

(2) National Emergency: e.g. during war to determine enemy character

Daimler v Continental Tyre & Rubber Co [1916] 2 AC 307, HL, Continental Tyre was incorporated in England.
German residents held all except one of its shares, and all the directors resided in Germany. The remaining
single share was held by the company secretary, a British subject living in England. The issue was whether
the company should be allowed to sue in the English courts to recover a debt when a state of war existed
between England and Germany.

It was held by the HL that, though incorporated in England, the company was capable of acquiring an enemy
character in time of war.

B. Statutory Provisions
(1) Criminal acts: When a company commits an offence under any ordinance, and it is proved that the
offence was committed with the consent or connivance of an officer concerned in the management of the
company, then he will be guilty of the same offence. (s 101E of the Criminal Procedure Ordinance (Cap 221))

R v Mirchandani [1977] HKLR 523, the company was charged under the Obscene Publications Ordinance
with having acted as agents for the distribution of allegedly obscene magazines. The company's officers were
charged with consenting or conniving in the offences. It was held that the words ‘consented’ or ‘connived’
covered a situation where the officers had deliberately shut their eyes to an obvious means of knowledge.
Their convictions were upheld.

(2) Fraudulent Trading (s 275) Companies (Winding up and Miscellaneous Provisions)

Ordinance ): If in the course of the winding up of a company it appears that any business of the
company has been carried on with intent to defraud creditors or for any fraudulent purpose, the
court, on the application of the Official Receiver, or the liquidator or any creditor or contributory of
the company, may, if it thinks proper to do so, declare that any person who were knowingly parties
to the carrying on of the business with such fraudulent intent are personally liable, without any
limitation of liability, for all or any of the debts or other liabilities of the company as the court may
direct.
Re William C Leitch Ltd [1932] 2 Ch 71, the court clarified the meaning of carrying on business with intent to
defraud. Maugham J said: ‘If a company continues to carry on business when there is to the knowledge of the
directors no reasonable prospect of the creditors receiving payment of their debts, it is, in general, a proper
inference that the company is carrying on business with intent to defraud ...’

However, in Re Patrick and Lyon Ltd [1933] Ch 786, Maugham J said: "I will express the opinion that the
words 'd efraud' and 'f raudulent purpose’... are words which connote actual dishonesty involving, according to
current notions of fair trading among commercial men, real moral blame."

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The ‘sunshine test’: In Re White & Osmond (Parkstone Ltd) [1960] ChD (unreported), Buckley J said:
"[T]here is nothing wrong in the fact that directors incur credit at a time when, to their knowledge, the
company is not able to meet all its liabilities as they fall due. What is manifestly wrong is if directors allow a
company to incur credit at a time when the business is being carried on in such circumstances that it is clear
the company will never be able to satisfy its creditors. However, there is nothing to say that directors who
genuinely believe that the clouds will roll away and the sunshine of prosperity will shine upon them again and
disperse the fog of their depression are not entitled to incur credit to help them get over the bad time."

In Akieselskabet Dansk Skibsfinansiering v Brother [2000] 1 HKC 511 (CFA), ADS claimed that Wheelock
Maritime International (WMI), a subsidiary of Wheelock Marden, obtained two loans from ADS at a time
when the person responsible for managing WMI knew that there was no reasonable prospect of the loans
being repaid. This was denied largely on the grounds that Wheelock Marden (the holding company) had
supported WMI in the past and there was genuine belief that it would continue to do so. The court’s decision
that the persons responsible for managing WMI had not been fraudulent was upheld by the Court of Final
Appeal. Lord Hoffman explained that ‘It is well established that s 275 requires proof that someone carried on
the business of the company with fraudulent intent and that the other directors sought to be held liable were
knowingly party to the fraud … the question whether the person carrying on the business was fraudulent was
subjective in the sense that he personally must have been dishonest.’

Who is ‘a party to the carrying on of the business’?

In Re Maidstone Building Provisions Ltd [1971] 1 WLR 185, it was held that a company secretary who knew
that the company was insolvent but failed to advise the directors to cease trading was not ‘a party to the
carrying on the business’ with intent to defraud creditors. Pennycuick V-C said: ‘I do not think it can be said
that someone is party to carrying on a business if he takes no positive step at all (to carry on a business). So in
order to bring a person within the section you must show that he is taking some positive steps in the carrying
on of the company's business in a fraudulent manner.’

(3) Misdescription of name of company: Where the company fails to pay the holder of a bill of exchange,
promissory note, cheque, or order for goods or money, any officer of the company or person who signed or
authorised the signing of that document on behalf of the company will be personally liable if the company's
name is not mentioned in the documents in legible characters. See ss. 659 to 661, Companies (Disclosure of
Company Name and Liability Status) Regulation.

Compare: Section of 26 of the Bills of Exchange Ordinance (Cap 19)(BEO) which provides the following for
person signing as agent or in representative capacity:

(1) Where a person signs a bill as drawer, indorser, or acceptor, and adds words to his signature, indicating that
he signs for or on behalf of a principal or in a representative character, he is not personally liable thereon; but,
subject to section 26A, the mere addition to his signature of words describing him as an agent, or as filling a
representative character, does not exempt him from personal liability.

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Section 26A of BEO provides:

(1) A person who makes, accepts or indorses a bill for, in the name of, on behalf of or on account of a
company shall not be liable in respect of that making, acceptance or indorsement where, on a proper
construction of the bill as a whole, that making, acceptance or indorsement is a making, acceptance or
indorsement of that company.

In Cheung Yiu-wing v Blooming Textiles [1975] HKLR 388, two cheques bore the name of a company and the
signatures of two directors. The cheques were dishonoured. It was held that although the company's name
was printed on the cheque, the directors were personally liable because they had failed to indicate sufficiently
that they were signing for or on behalf of the company.

This case was distinguished, however, in Kwok Wing v Maytex Trading Co [1977] HKLR 149, in which eight
cheques were drawn in favour of Maytex in payment for goods which they had supplied. Each cheque had the
name of ‘Texfarm Garments Factory Limited’ and the number of the company's bank account printed on the
face of it, was signed by Kwok Wing, and surrounding his signature was the impression of a rubber stamp
with the words ‘Texfarm Garments Factory Limited’ above the signature and the word ‘director’ below the
signature. It was held that the position and qualified manner in which Kwok Wing placed his signature on the
cheques showed that the signature was to authenticate the impression of the company's stamp, that the
impression and the signature together formed the ‘composite signature’ of the company, and that the liability
under s 26 does not apply where a person affixes his signature as part of the composite signature of the
company.

(4) Entering into a relevant accounting transaction when the company has become dormant:
Any shareholder of the company who knew or ought to have known about the relevant accounting
transaction and all directors of the company shall be personally liable for any debt or liability of the
company arising out of the relevant accounting transaction. (ss. 5, 447, 611, 663 NCO)

(5) Misapplication of funds:

Section 276(1) Companies (Winding up and Miscellaneous Provisions) Ordinance )
If in the course of winding up a company it appears that any person who has taken part in the formation or
promotion of the company, or any past or present officer or liquidator or receiver of the company, has
misapplied or retained or become liable or accountable for any money or property of the company, or been
guilty of any misfeasance or breach of duty in relation to the company which is actionable at the suit of the
company, the court may, on the application of the Official Receiver, or of the liquidator, or of any creditor
or contributory, examine into the conduct of the promoter, officer, liquidator or receiver, and compel him
to repay or restore the money or property or any part thereof respectively with interest at such rate as the
court thinks just, or to contribute such sum to the assets of the company by way of compensation in respect
of the misapplication, retainer, misfeasance, or breach of trust as the court thinks just.

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(6) Civil and criminal liabilities for misstatements in prospectus (see ss 40 & 40A Companies
(Winding up and Miscellaneous Provisions) Ordinance )

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