FACULTY OF BUSSINESS SCIENCE DEPARTIMENT OF MANAGEMENT SCIENCE

MODULE: COMMERCIAL LAW

MODE OF ENTRY: VISITING

LEVEL :2.1

TINASHE MSONZA R243707C

DOUGLISH.S MIKAYIRI R242952N

FRANCISCA MANYOWA R242649Q

PLAXEDES TAONEYI R2215594J

The general legal principles are that a company has a separate legal existence from that of its
members. In what circumstances does that general principle not apply? Give examples of
such situations [25]

The principle of separate legal personality is a cornerstone of corporate law, establishing that a
corporation is a distinct legal entity separate from its shareholders or members. This principle
allows a corporation to enter into contracts, own property, and be liable for its own debts.
However, there are specific circumstances under which this principle may not apply, allowing
courts to "pierce the corporate veil" and hold shareholders or directors personally liable. This
essay explores various exceptions to the principle of separate legal personality, providing in-
depth analysis and examples to illustrate these circumstances.

The Principle of Separate Legal Personality

The doctrine of separate legal personality was firmly established in the landmark case of
Salomon v. Salomon & Co. Ltd (1897). In this case, Mr. Salomon, a boot manufacturer, formed a
limited company, transferring his business to it. When the company failed, creditors sought to
hold Salomon personally liable for the company's debts. The House of Lords ruled that the
company was a separate legal entity, thus protecting Salomon from personal liability. This
ruling established the foundation for limited liability and corporate governance (Moore, 2020).

The Importance of Separate Legal Personality

The principle of separate legal personality serves several critical functions in corporate
governance: Limited Liability: Shareholders are only liable for the debts of the company up to
the amount they invested. This encourages investment by reducing the financial risk to
investors (Gibson Sheat, 2021).

Continuity of Existence: A corporation continues to exist independently of its shareholders,

allowing for perpetual succession even in the event of death or insolvency of its members
(Mason, 2019) Legal Capacity: Corporations can own property, sue and be sued, and enter
contracts in their own name, facilitating business operations (Moore, 2020).

Despite these benefits, the rigid application of this principle can lead to potential abuses,
prompting courts to examine situations where it may be just to disregard the corporate entity.

Circumstances Where Separate Legal Personality Does Not Apply

Fraudulent Conduct
One of the primary circumstances under which courts may pierce the corporate veil is in cases
of fraudulent conduct. When a corporation is used as a vehicle for fraud or to avoid legal
obligations, courts are more likely to hold individuals accountable for the company’s actions.

Example: In Gilford Motor Co Ltd v. Horne (1933), Mr. Horne, a former employee, established a
new company to circumvent a non-compete clause in his contract with Gilford Motor Company.
The court found that the new company was merely a façade for Horne’s fraudulent activities
aimed at undermining the original company. The court held Horne personally liable for the
debts of the new company, emphasizing that the corporate structure was being misused to
perpetrate a fraud (Gibson Sheat, 2021).

Agency or Alter Ego Theory

Another situation where separate legal personality may not be upheld is when the company
acts as an agent or alter ego of its shareholders. In these cases, the company does not function
independently but instead operates solely on behalf of its members.

Example: In Bona fide Investments Ltd v. D.J. Khosla (1986), the court ruled that the company
was essentially acting as an agent for its shareholders. The shareholders were using the
corporate structure to conduct their personal business, and the court found it just to disregard
the corporate entity, holding

the shareholders personally liable for the company's debts. This case illustrates the principle
that if a corporation is merely a façade for individual activities, the courts may look beyond the
corporate form (Moore, 2020).

Commingling of Assets

Commingling of assets refers to situations where personal and corporate assets are mixed,
making it difficult to distinguish between the two. Courts are likely to pierce the corporate veil
in such cases, as it suggests a disregard for the separate legal entity of the corporation.

Example: In Re: Seddon (1998), the directors of a company used corporate funds for personal
expenses, failing to maintain distinct financial boundaries. The court ruled that because the
directors' personal finances were intertwined with those of the company, the separate legal
personality could not be upheld. The ruling emphasized the importance of maintaining clear
boundaries between personal and corporate finances to preserve the integrity of the corporate
structure (Gibson Sheat, 2021).

Statutory Exceptions
Certain statutory provisions may also provide grounds for disregarding the separate legal
personality of a corporation. These laws often aim to protect the public interest or prevent
abuse of the corporate form.

Example: Under the Companies Act 2006 in the UK, specific provisions allow the courts to lift
the corporate veil in cases involving improper conduct. For instance, if an individual uses a
corporate structure to evade statutory responsibilities, such as health and safety regulations,
the courts may hold that individual personally liable. This statutory framework aims to ensure
that individuals cannot misuse the corporate form to escape accountability (Moore, 2020).

Public Policy Considerations

Courts may also disregard the separate legal personality of a company based on public policy
considerations. When the enforcement of limited liability would undermine public interest,
courts may choose to pierce the corporate veil.

Example: In Prest v. Petrodel Resources Ltd (2013), the Supreme Court of the UK held that the
veil could be pierced in situations where the company was used to conceal the true ownership
of assets. The case involved a divorce settlement where the husband had transferred assets to
companies he controlled. The court found that allowing the husband to shield assets within the
corporate structure would be contrary to public policy, leading to a ruling that the assets were
to be treated as belonging to him personally (Mason, 2019).

Inadequate Capitalization

Inadequate capitalization occurs when a company is formed without sufficient capital to meet
its business obligations. Courts may pierce the corporate veil in these cases, particularly if the
company was intentionally undercapitalized to avoid liabilities.

Example: In Re: A Company (No. 005074 of 1989 (1991), the court found that the company was
set up with minimal capital, making it unable to meet its debts. The judge emphasized that the
shareholders had intentionally undercapitalized the business to limit their liability. As a result,
the court held the shareholders personally liable for the company's debts, reinforcing the
principle that companies must maintain adequate capitalization to protect creditors (Gibson
Sheat, 2021).

Implications of Disregarding Separate Legal Personality

The ability of courts to pierce the corporate veil underscores the balance between protecting
the rights of shareholders and ensuring accountability. While the principle of separate legal
personality provides significant advantages, such as limited liability, the exceptions highlight the
importance of ethical corporate governance.
Promoting Accountability

By holding individuals accountable in cases of fraud or misconduct, the courts reinforce the
expectation that corporate entities must operate transparently and in good faith. Failure to do
so may result in personal liability for directors and shareholders, which serves as a deterrent
against the misuse of corporate structures (Mason, 2019).

Impact on Business Practices

Understanding the circumstances under which the corporate veil can be pierced is crucial for
business leaders. Companies must maintain clear financial boundaries, adhere to statutory
requirements, and avoid fraudulent conduct to protect their limited liability status. Awareness
of these legal principles can guide corporate governance practices and promote ethical business
operations (Moore, 2020).

Legal and Financial Consequences

The consequences of disregarding separate legal personality can be severe. Directors and
shareholders may face personal financial liability, loss of reputational capital, and increased
scrutiny from regulatory bodies. Companies that fail to maintain compliance with legal
standards risk not only financial penalties but also damage to their brand and stakeholder trust
(Gibson Sheat, 2021).

In conclusion the principle of separate legal personality is a cornerstone of corporate law,

providing essential protections for shareholders and promoting business efficiency. However,
the circumstances under which this principle may not apply highlight the need for responsible
corporate governance. By understanding these exceptions, business leaders can better navigate
the complexities of corporate law while ensuring compliance with ethical standards. Ultimately,
the balance between protecting individual interests and promoting accountability is crucial for
maintaining the integrity of the corporate form.
References

Gibson Sheat. (2021). Piercing the Corporate Veil: A Legal Overview. Retrieved from [Gibson
Sheat] (https://www.gibsonsheat.com/)

Mason, J. (2019). Corporate Law: Principles and Practice. Oxford University Press.

Moore, A. (2020). Corporate Personality and the Law: A Comprehensive Guide. Cambridge
University Press.

Prest v. Petrodel Resources Ltd [2013] UKSC 34.

Re: A Company (No. 005074 of 1989) [1991] BCC 507.

Re: Seddon [1998] 1 BCLC 243.

Salomon v. Salomon & Co. Ltd [1897] AC 22.

Gilford Motor Co Ltd v. Horne [1933] Ch 935.

Bona fide Investments Ltd v. D.J. Khosla [1986] 1 NZLR 52.