Under the concept of separate legal entityDocument Transcript
Under the concept of separate legal entity, a company will becomes a body corporate
that exists separately with its owner and distinct from its individual members and directors. In
others word, the corporation is an entity just like human being created using legal and official
A company once created by the law can only be terminated by the process of law. The
company exist in its own capacity and making business, generate its incomes and revenues,
incur its own specific losses, hire employees for many areas and pay for its own tax. It is
betterto recognize the company as a separate entity because the owners can enjoy the limited
liability and risk based on their investment in stock. However, under this concept, the
company is treated in its own capacity. In addition, it has to be reminded that the company is
not human nor a machine. Hence, it cannot operate by it ownself. Therefore, as for the
essential requirement, the company must gather a group of people of different capacity and
area to manage it ethically and represent it in their own vested authorities respectively.
The separate legal entity has its roots in the landmark case of the English House of
Lord in Salomon v A Salomon & Co Ltd1
.Looking on the earlier cases, separate legal entity
principle can be seen firstly illustrated in R v Arnaud2
case. In this case, a registering
authority refused to register a ship based on the ground that the owners of the ship include
foreigners. The ship was owned by a British chartered company, whose members happened to
include foreigners. The court ordered the registering authority to register the ship, on the basis
that the British company was the ship‟s owner rather than the members of the company.
However, the unanimous decision of the House of Lords in Salomon v A. Salomon & Co. Ltd
is regarded as a landmark in Company Law which assured that a company is a separate legal
entity together with distinct legal personality.
In the modern business corporations, it can be seen that shareholder has its limited
liability for the corporation‟s debts and obligations. Thus, it clearly creates a double-edged
sword, which literally means it has both good and bad elements. However, the principle of
this case occupies a remarkable position in the development history of company law.
Meanwhile the following development since this case has gives some proves that the separate
legal entity can be considered as double-edged sword.
 AC 22
 9 QB 806
In the case of Salomon v A Salomon & Co Ltd, the facts of the case are as
following.Mr. Salomon sold his shoe business to a company which he had set up for the
purpose under the Companies Act. The registration under the Act was completed and the
members of the company consists of Salomon and his family, particularly, Mr. Salomon
received fully-paid shares and debentures to the value of £10,000, in which he subsequently
assigned to another party. The business seen to be declined and the company went into
insolvent liquidation. The liquidator attempted to hold Mr. Salomon liable for the debts of the
company with arguing that the whole transaction was a fraud on the company‟s creditor and
Salomon should not be allowed to benefit, additionally, the liquidator claimed the company
was simply an agent of Salomon, as a result, he should indemnify the company (and its
creditors) with respect to the debts incurred by the company. In this case, the House of Lords
held that :
1. Salomon was neither under liability to the Salomon Company nor to the creditors of
the Salomon Company.
2. Salomon‟s debentures were validly issued.
3. Lord Halsbury LC remarked that statute had enacted the formal and procedural
requirements upon registration of a company but did not enact requirements regarding
the extent or degree of interest which may be held by each of the subscribers or as to
the proportion if influence processed by one or the majority shareholder over the
4. The House noted that after registration of a company, although the business may be
the same as before and the same hands receiving profits, but in law the company is not
an agent of the subscribers or members.
However, it should be noted that the House of Lords decision in this Salomon's case really
only decided that Salomon & Co Ltd was a company duly incorporated under the Companies
Act 1862 (UK), even though its seven shareholders were not truly „independent' as all of the
statutory requirements were satisfied because the company had consists of seven
Pursuant to the decision of the House in Salomon‟s case, we can summarize up to four
points based on the proposition that incorporated companies have a separate legal personality:
(a) Company's property is company's property;
(b) Company's debt is company's debt;
(c) Companies can contract with their members, directors and outsiders;
(d) Companies can commit torts and crimes.
These four points had been reasserted in many cases. Firstly, the point on the
company's property is company's property. This point had been applied in the case of
Macaura v Northern Assurance Co.3
In this case, the appellant, Mr. Macaura has claimed for
payment of insurance for his company, but his request was refused by five insurers. These
insurers claimed that Mr. Macaura did not have an insurable interest for the insurance which
was bought in Mr. Macaura's name rather than the company's name. The court upheld the
insurer's decision and concluded that “the corporator, even if he holds all the shares, is not the
corporation, and that neither he or any creditor of the company has any property, legal or
equitable, in the assets of the corporation.” This decision implies that, although the principle
is not in favour of the person registering the company, these principles should also be applied.
Secondly, the point of company's debt is company's debt. In the earlier facts, it had
already been clearly addressed in Salomon case by the House. Thus, this point specifically
mentioned about the company responsibility towards its own debt.
Moving on the point of where companies can contract with their members, directors
and outsiders, it was indeed developed in Lee v Lee's Air Farming Ltd4
. In that case, Mr.
Lee's accountant formed a company (Lee's Air Farming Ltd), and Mr. Lee was the principal
shareholder also the governing director of this company. The company contracted with
farmers to perform aerial topdressing. Mr. Lee worked for the company as a pilot and
received a wage for that work. In a work accident, Mr. Lee died then his wife claimed on a
workers compensation insurance policy that the company's solicitor had taken out naming Mr.
Lee as an employee. The insurer denied liability on the ground that Mr. Lee could not be a
servant because he was a director of the company. The Judicial Committee of the Privy
Council upheld the claims made by Mrs. Lee and firmly rejected the insurer's argument. Lord
Morris quoted Lord Halsbury LC's judgment in Salomon's case, that company „was a real
thing' and noted that:
 AC 619
 N.Z.L.R 325
“… Always assuming that the respondent company was not a sham, then the capacity of the
respondent company to make a contract could not be impugned merely because the deceased
was an agent of the respondent company in its negotiation [of Mr Lee's contract of service].”
The decision in Lee v Lee's had also been applied in the case of Industry v Bottrill5
where the court pointed out that a sole shareholder can be employed by the company and will
have rights under the Employment Rights Act 1996.These solutions confirm that a company
is able to employ one of its members under a contract of service including its principle
Finally, companies is liable and can commit torts and crimes. The decision as stated in
the case of Lee v Lee‟s Air Farming Ltd shows that companies may be liable to tort since
companies have a separate legal personality and are able to contract with others.
In conclusion, the Salomon case is famously regarded as a landmark in the UK's
Company Law since this case had established fundamental principles related with Company
Law. According to the Salomon case, a company is both an association of its members and a
legal person separate from its members, “ a company's property is owned by the company as a
separate person, not by the members; the company's business is conducted by the company as
a separate person, not by the members; it is the company as a separate person that enters into
contracts in relation to the company's business and property”.
There are many arguments arises in the decision of Salomon v A. Salomon Co Ltd. It
can either be in positive arguments as well as negative arguments.
For positive side of the arguments, the separate legal entity principle has shown that it
has clearly able to survive from time to time because it has meant the company does have
practical utility. As a separate legal entity is subject to limited liability and defined by some
attributes of incorporation, the corporation has many economically and socially beneficial
Firstly, on the matter of separate legal entity, by separating the management from
investment, a company will enable to the investing public to share in the profits without being
involved in any management of their business. In the meanwhile, professional managers can
 EWCA Civ 781
be hired by a company for a reason to provide professional management of business and this
may probably gives effect as in a better profit for the company. Next, as a person created by
law, the personality of the association is highlighted. A company can „live' long enough to
carry on certain business without worrying on the matter about biological death. Based in this
statement, it may reach the achievements made by its next generations of members. Lastly,
according to limited reliability principle, investors are merely reliable to the share which they
subscribe for so that the risk ofinvestment has been reduced.
In simple, company as a vehicle of business can collect huge amount of outside capital
for business efficiently. It also provide considerable convenience and confidence to the
investors. Consequently, the investors will make some investments as investments are
fortified by the company. Furthermore, economic growth has been boost and the development
of society is promoted.
Meanwhile, there are also negative arguments arises. Among the negative arguments
such as the decision in the Salomon case has been criticized by many academic scholars. One
of the expert, Professor Kahn-Freund even described it as “calamitous” where he claimed that
the decision cause a number of problems, for instance, “How is it possible to check the one-
man company and other abuses of company law?”6
. The House of Lords confirmed the usage
of the corporate form by individual traders and small partnerships in emphasizing the
independent status of corporate personality. Other experts such as Tomasic and Bottomley
mentioned this result in that private enterprises which do not seek to raise capital from the
public can interpose an entity between themselves and their creditors7
. The Law Lords
concluded that, once a person completed the process of registration required by the Act, a
company forms a legal entity separate from its shareholders, even where there is only a bare
compliance with the provisions of the Act and where all, or nearly all, of the company's issued
shares are held by one person. Furthermore, Gower pointed out that the Court held that it was
possible for traders not merely to limit their liability to the capital which they invested in the
enterprise but even to elude any serious risk to the major part of that by subscribing for
debentures rather than shares8
. Salomon's case was not about “a dry point of construction.”
noted in The Law Quarterly Review, The House of Lords emphasized on the separate identity
of the legal form and essentially ignored the economic reality of a one-person company.
Kahan-Freund, Some Reflections on Company Law Reform, MLR 1944
Roman Tomasic and Stephen Bottomley, Corporations Law in Australia, The Federation Press, Sydney 1995
LCB Gower, Gower’s Principles of Modern Company Law, 5th Edition, Sweet & Maxwell, London 1992
According to the criticism of the decision made in Salomon case, negative effects of
the separate entity principle may be concluded into two main aspects.
Firstly, the Salomon principles are vulnerable in protecting interests of outside
creditors. The Salomon case gives the benefits of limited liability to even apparently honest
incorporators in circumstances which it is not necessary in order to encourage them to initiate
or carry on their trade or business. According to the separate legal entity principle,
management of business is separated from shareholders and due to the benefits of limited
liability, shareholders are discouraged in monitoring and controlling their company's
commercial ventures. However, a limited company's creditors must look at the capital, the
limited fund of the company.
In addition, pursuant to the separate legal entity principle, subsidiaries can be easily
abused to avoid debts by transferring assets between parent company and subsidiaries.
In conclusion, in accordance with the principle of separate entity, company is regarded
as separate legal entity. Thus, it is reliable to the debts of its own. Therefore, creditors of the
company are prevented from claiming their rights directly to those real debtors (shareholders).
This generally implies that, in practice, creditors (both contracting creditors and tort creditors
include) bear more risk when they dealing with a limited corporation. By contrast, according
to benefits of limited liability, shareholders of the company are highly protected by law and
bear less risk of the insolvency of the company.
Secondly, the separate legal entity principle provides an ideal vehicle for fraud. Ever
since the Salomon case, legal doctrine regards each corporation as a separate legal entity.
“When coupled with the consequent attribute of limited liability, the Salomon principle
provides an ideal vehicle for fraud.” Nowadays, the form of corporation has been abused for
the development of many different forms of fraudulent or anti-social activity.
In the context of Malaysian legal aspect, it can be seen in the case of Abdul Aziz bin
Atan & Ors v Ladang Rengo Malay Estate Sdn. Bhd.9
This case concerns the proper
application of reg 8 of the Employment (Termination and Lay-Off Benefits) Regulations
1980. All the shareholders of the respondent company by a written agreement sold and
transferred their entire shares to a certain buyer in 1981. The main asset of the company
 1 CLJ 255
consisted of land on which the company appeared to have carried on the business of a rubber
estate and oil palm. In November 1982, a claim, said to be for April 1982, was initiated under
s 69 of the Employment Act 1955 for termination benefits under reg 8. The point in dispute
was whether the estate was sold and if so whether a change of employer took place. The court
held that, in dismissing the applicants‟ appeal: an incorporated company is a legal person
separate and distinct from the shareholders of the company. In the present case there was no
change whatsoever in the constitution of the respondent company. The company did not
change its identity or personality. It continued to own all the assets of the estate which were
an integral part of the business for the purposes for which the applicants were employed.