Corporate Personality and Limited Liability Salomon v. Salomon and Co Ltd



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Business Organizations Law Outline

Prepared by Jennifer Dundas

Professor Chisick’s section, Fall 2001
(This is not your typical outline. In addition to case briefs, it contains excerpts of cases, articles, and postings on the BusOrg forum. If you’re looking for something concise, this isn’t it.)
Corporate Personality and Limited Liability
Salomon v. Salomon and Co Ltd. [1897] A.C.22 (H.L.) Salomon was a leather merchant and boot manufacturer. He registered his company in the names of his family members and himself, satisfying the sole requirement of setting up a corporation – that there be seven signatories to the “memorandum of association.” He held more than 20,000 shares. The six family members held one share each. He issued himself a secured debenture worth L10,000. In addition, the business had several unsecured creditors. When Salomon went bankrupt, he wanted first dibs on the assets, with his secured debenture. The unsecured creditors would left to divvy up the rest.

Issue: was the corporation a separate legal entity from its creator and de facto sole owner.

Held: a corporation is a separate legal entity, with all the rights and privileges of a natural person.

Ratio:


  • a corporation’s legal personality is separate from all others – including its shareholders.

  • There is no requirement that S/H must hold their shares beneficially, and therefore no objection to the de facto one-person corporation.

This has been codified:

CBCA s.15(1) – A corporation has the capacity and, subject to this Act, the rights, powers and privileges of a natural person

Lee v. Lee’s Air Farming Ltd [1961] A.C. 12 (Privy Council) Lee formed an aerial spraying company, was the controlling shareholder in it (holding all but one of the shares), its governing director “for life”, and was employed as its chief pilot. A statute required that the company insure itself (worker’s comp) in case of accident to him. He was killed while flying for the company.

Issue: Can a governing director of a company also be a servant of the company, i.e. a worker in the sense of the Workers’ Compensation Act? Is a company the agent of its owner, rather than a separate legal entity, when its creator is also the only shareholder, the only governing director?

Held: The company and the deceased were separate legal entities.


  • One person can be director, shareholder and employee of the same company simultaneously. (this would not be possible with a partnership.


Macaura v. Northern Assurance Co. Ltd., (1925 H.L.) M owned some timber, which he transferred to a company that he created and of which he was sole shareholder. Fire destroyed the timber. M had insurance on the timber as an owner, but he was no longer an owner. He had became a creditor. The company itself had not insured the timber, the company was the owner of the timber. M’s insurance policy was found to be invalid, in that he held it against assets he had no claim against.

Ratio : An insurable interest requires either a legal or equitable interest in the goods.



  • A shareholder has no insurable claim on the assets of the company.

Comments : A share is a bundle of rights against a corporation. Although a share is personal property, the claim that it represents in the corporation is NOT a property right in the corporation’s assets. He could only insure either as a creditor or a SH in the company, NOT as owner. However, the company could insure as owners. In this case there was moral certainty that M would suffer loss if the timber destroyed. This moral certainty becomes dissipated with increased assets and increased SH.

Distinction from Salomon – M was an unsecured creditor.

Kosmopoulis et al v. Constitution Insurance Co of Canada et al [1987] SCC: Kosmopoulis and his wife opened a leather goods store in Toronto – Spring Leather Goods. He set his business up as a corporation, to protect his personal assets. He was the sole shareholder and director. However, his lease was in his own name. His insurance policy was insured to Andreas Kosmopoulos O/A Spring leather goods.

Issue: Can a sole shareholder take an interest in the property of the company for insurance purposes, when he has no legal or equitable interest in the property otherwise (being simply entitled to a share in the profits and a distribution of the surplus assets when the co. is wound up?)

Held: A sole shareholder may lay a claim for insurance purposes on the assets of a corporation. Kosmopoulis was allowed to claim the insurance benefits.

Ratio:


  • if the corporation’s loss of property would be essentially the shareholder’s loss of property, i.e. they are one and the same, then the shareholder may insure the property.

Reasoning: The Ont. CA rejected the precedent in Macaura, which held that one of the three shareholders involved did not have an insurable interest in corporate property, unless he held a lien or charge on the insured property. It distinguished Kosmopoulos by noting that it had one, sole shareholder. Wilson J for the SCC accepted this and went further, quoting Laurence J. in Lucena and saying “if an insured can demonstrate [ ] some relation or concern by the happening of the perils insured against may be so affected as to produce a damage, detriment, or prejudice to the person insuring, that insured should be held to have a sufficient interest.” “ Mr. K, as sole shareholder of the co., was so placed with respect to the assets of the business as to have benefit from their existence and prejudice from their destruction. …He had, therefore, an insurable interest in them capable of supporting the insurance policy….” This application of the Lucena ratio would seem to open the door to multiple shareholders being able to claim for insurance purposes. In dissent, McIntyre J. would also have allowed Kosmopoulis’s claim to insurance benefits, but he would have done so on the basis of the reasoning in the Ont. CA decision, which was narrower, and applied only to sole shareholders.

Corporate Contracts
Duha Printers (Western) Ltd v. Canada [1998] SCC:

Corporate Liability in Tort
The Rhone v. The Peter A.B. Widener [1993] SCC: A barge, The Widener, was being towed by four tugboats when it went off course. The lead tugboat had set a pace that was too fast for the turn that had to be negotiated. The barge crashed into The Rhone, and damaged it. The owners of the Rhone wanted the owners of the Widener to be liable for all damages, but the Canada Shipping Act limits vicarious liability of the owners of ships involved in accidents caused by its employees. The only way the Widener could get full damages from the offending company was if the person responsible was not considered an employee of the shipping company, but the “directing mind” of the company. In this way, the company itself could be seen to be acting “with fault or privity”, and therefore fall outside the protections of the CSA.
Issue: Is a ship’s captain acting as the “directing mind” of the ship, when making operational decisions about the voyage, thereby invoking the “identification doctrine”.?
Held: A ship’s captain is an employee, not the directing mind of the corporation. The “identification doctrine” does not apply.
Ratio: Operating with a high degree of autonomy does not automatically confer “directing mind” status to the employee. Carrying out operational matters within established policy does not invoke the “identification doctrine.”

Analysis: It is a finding of fact to determine exactly who was making what decisions. The question of law is whether the persons in question invoke the “identification doctrine”. Haldane: “It is not enough that the fault should be the fault of a servant in order to exonerate the owner, the fault must also be one which is not the fault of the owner, or a fault to which the owner is privy….” The amount of discretion accorded an employee is significant. He/she must not simply be carrying out policy, but must be responsible for development or design of that policy as well. Making decisions about operational requirements, even decisions that carry a lot of weight, does not making one a directing mind, if those decisions are made within the confines of existing policy.

Corporate Criminal Liability
R. v. Canadian Dredge and Dock Co [1985] SCC
Facts: Three companies were accused of fraud for rigging bids. The employees involved would benefit personally, and so would their companies.
Issue: When are companies criminally responsible for the actions of their employees?
Held: “Identification doctrine” operates when an employee acts as the “directing mind” of a corporation. Three conditions must be met:

1) the employee must be operating within his/her assigned field of operation,

2) the employees actions must be not totally in fraud of the corporation (i.e. committing fraud but still conducting regular duties)

3) the corp must benefit, at least partly.

Advising employees not to engage in fraud is not a defence, although taking substantial and concerted efforts to detect and deter fraud may be. This is not ruled out.
Reasoning: The corporation has become the principle vehicle of commerce in the community. To fail to find it liable for criminal acts would limit the administration of justice. However, when employees turn on their employer, and act against its interests or completely separate from them, the corporation is no longer responsible for their acts.

Chisick says it would be unlikely that the individual responsible for the criminal act would be found innocent, while the corporation was found guilty, despite the fact that legally they are two separate entities. From a policy standpoint, the courts would not want to allow individuals to escape liability by hiding behind the identity of a corporation.


Caveat: Estey spoke of executing a scheme to deprive the corporation of any and all benefit, where the “entire energies” of the directing mind are directed “to the destruction of the undertaking of the corporation.” Chisick says this is overstating the case, but nevertheless it’s there. This quote could be used to argue against a finding of liability, even if the above criteria appear to have been met.


In General: The tension that exists between individual responsibility and corporate responsibility plays out in three ways:


  • Are we dealing with an employee, director or shareholder?

  • Is he/she a directing mind?

  • Is it a corporate tort or a personal tort?


R. v. Church of Scientology et al. [1997] 33 O.R. (3d) (CA)

Facts: The “Guardian’s office” of the Church of Scientology in Toronto carried out an intelligence-gathering operation that involved getting its agents to take jobs in the civil service and elsewhere, to obtain documents and information that was being held by these offices. This operation resulted in charges of theft and breach of trust. The Guardian’s office ,on paper, was a separate entity from the Church of Scientology of Toronto (Inc.) -- a non profit corporation. However, the Guardian’s office controlled the non profit corp, and it was supported financially by it. The non-profit group’s board of directors were essentially figureheads who took orders from the Guardian’s office.
Issue: 1) Were the members of the Guardian’s office who carried out the intelligence-gathering operation the directing minds of the non-profit group, thereby invoking the “identification doctrine”, or should the doctrine be limited to the board of directors, and those delegated by it to exercise its authority (as per Rhone)?

2) Should the identification doctrine apply to a non-profit group?


Held: 1) The Guardian’s office acted as the controlling mind of the church, even though officially it was a separate entity.

2) Non profit groups are captured by the doctrine.

Ratio: 1) The controlling mind of an organization does not have to be explicitly connected to the board of directors -- either themselves or their delegates. De facto control is sufficient.

2) All incorporated groups are subject to criminal liability for the acts committed by the people who are their “controlling minds”.

Reasoning: 1) There does not need to be strict adherence to the dicta in Rhone, which was premised on a corporate structure in which ultimate authority lies with the board of directors. In Rhone, that authority had to be held expressly or impliedly by the people who did the illegal acts, for the corporation itself to be liable. In this case, the fact that the board of directors were mere figureheads means the dicta in Rhone and Canadian Dredge must be adapted, so that the underlying principles are still given effect. (“To do otherwise would mean that this corporation had no directing mind. This is simply not a sensible or pragmatic position.”) In this case, the court looked to who held de facto control.

2) Since corporations occupy such a central role in our society, not just in our economy, it would be unacceptable to have any of them, including non profit corps, operating outside the criminal law.


(Possible exam question: consider a scenario such as the one above, where the people holding de fact control are outside of the “official” organization, but their implicit authority is then delegated to others. You would have to draw on this precedent to establish the possibility of liability outside of the strict hierarchy of the corporation. But then you would have to look to Cdn Dredge and Rhone to determine whether or not the delegation was sufficient to include policy matters, and thereby invoke the identification doctrine.)
Kosmopoulis et al

There is a real blurring of the lines here between personal and business. Kosmopoulis decides to take out insurance on a store, and does so as Kosmopoulis O/A Spring Leather Goods. A fire occurs, and the insurance company refuses to pay. It says K O/A does not have an insurable interest in the business. In fact, they argue there is no contract of insurance – without an insurable interest there is no contract.

What is an insurable interest? You have to be able to derive a benefit or suffer a harm from the change of the nature of an item.
In Lucena v. Craufurd et al the court (Lawrence J.) said there had to be a “moral certainty” that an individual had advantage or prejudice in an item regarding the insurable interest. In other words, it would allow a person to have an insurable interest in corporate property, without it being the person’s property. In Kosmopoulis, Zuber JA says regarding the separate legal entity principle: “The law on when a court may disregard this principle by “lifting the corporate veil” and regarding the company as a mere “agent” or “puppet” of its controlling shareholder or parent corporation follows no consistent principle. The best that can be said is that the “separate entities” principle is not enforced when it would yield a result “too flagrantly opposed to justice, convenience or the interests of the Revenue:” LCB Gower, Modern Company Law.”
The court would like to help Kosmopoulis, but it has a problem – The Macaura principle, which states neither a shareholder nor a creditor may derive an insurable interest in a property.
Macaura
Macaura was a shareholder and creditor in a timber corporation. He had insurance, but when the timber went up in flames, the court said Macaura had no insurable interest. The problem hinged on the fact that there was more than one shareholder.
Why is that a problem? Why are they so reluctant to do this? Court said there are three shareholders and a bunch of asserts, how do we know whose assets are whose?
*** The court’s concern was that if they allowed each shareholder to have an insurance claim on the company, you would have “x” number of claims against the same assets, since you can’t determine who owns what. ***

The problem is then that a shareholder interest cannot be identified. If a shreholder with 25% of the shares takes out insurance on 25% of the company, and a fire destroys 25% of the company’s assets, how do you know it was that shareholder’s 25%?

In Kosmopoulis, how did the court deal with Macaura? The Ont. Court of Appeal read it down, and said the principle only deals with multiple shareholder companies. Single shareholder companies can be subject to insurable interests by their owner.
Does that make sense? The question is, Why does the court have the right to look behind the corporate veil. Is this good policy? Should the number of shareholders be relevant? The corporation is an individual person – What would happen if in each tort case we looked at an individual person’s background? Can we lift the veil of an individual person?
Ultimately, the SCC struck down Macaura. Now we have gone back to Lucena. You simply have to show that you have a benefit or a prejudice in an item to get an insurable interest in it – “benefit from their existence and prejudice from their destruction.”
Possible exam questions:
Kosmopoulis addresses the rights of a shareholder to an insurable interest in corporate property, but can it be applied to the rights of a creditor? What if there are multiple creditors? Would make a difference if the person were a secured creditor?

A lender of money for the construction of a property will want to be able to insure the property against loss. Macaura disallowed an analogous claim, but Kosmopoulis overturned that case, and would seem to allow this. On the other hand, the Macaura claim involved someone who was both a shareholder and creditor. To be solely a creditor was not dealt with directly in Macaura, and so the principle of creditors not being able to have an insured interest was not explicitly overturned by Kosmopoulis. In adopting the more permissive precedent of Lucena, the court has restored the principle that anyone who derives benefit from a property and would suffer loss from the loss of property can take out insurance in that property. The question thus becomes, does the creditor benefit from the continued integrity of the property, and does it matter whether that benefit is a direct benefit, i.e. the property produces income that by contract goes directly to the creditor, or that the benefit is indirect, i.e. the company that owns the property won’t be able to generate the income necessary to pay the creditor without the continued existence of the property. If the owner of the property, be it a person or corporation, has other means by which to discharge the debt to the creditor, perhaps the creditor’s interest in the property is weakened. His/her real interest is in the viability of the company that owns the property, a company that may well own many other properties, and be able to withstand the loss of one piece. Perhaps it would make a difference if the creditor were a secured creditor, and the security is the property. In that way, it could be clearly demonstrated that the loss of the security is a loss to the creditor, who now has no way to guarantee payment of the loan. The secured creditor thus meets the criteria for both deriving benefit from the property, and suffering prejudice from its loss, thereby meeting the minimum terms established by Lucena, and confirmed in Kosmopoulis.

(from Quicklaw article)


TITLE/TITRE:




The Supreme Court in Flames:  Fire Insurance Decisions After Kosmopoulos







AUTHOR/AUTEUR:

Reuben A. Hasson


The courts will not allow a person to essentially gamble on getting a windfall, by buying insurance on property held by another. One has to actually be in a position where one suffers damage from the loss of the property. When wagering, one is not seeking to protect against economic loss (one of the requirements for a viable insurance claim in Kosmopoulis; the object is to make a windfall gain.)

Would an individual be able to insure public property, such as a road, damage to which would cause him or her loss? (This was an 1888 case referred to in the article cited above.) How would you argue either way?

-- too far removed from the owner of the property. Not like lifting the corporate veil, as in Kosmopoulis. There is no relationship of ownership such as there was in Kosmopoulis. There is not even the relationship of being a creditor, which causes one to suffer direct loss. The damage to the road might be tens of thousand of dollars, whereas your business is worth a fraction of that. To what extent are you entitled to insurance – the value of your lost business, or the value of the road, which you have insured? If you were entitled to the value of the road you had insured, you might be getting a windfall from its loss. On the other hand, an insurer will charge you premiums relevant to the potential claim. With freedom of contract, if both sides know what they’re getting into, and you have paid the premiums appropriate for such a claim, why not allow it? If it’s worth that much to the insuring person. and the insurance company is willing to take on the risk, so be it. That’s freedom of contract between individuals.

-- if one is utterly dependant on public property for the viability of one’s business, in insuring that property, one is in effect insuring one’s own business. Therefore, the best policy would simply be to have the insurance on one’s business cover losses caused by damage to property owned by others on which one is dependent.


The Limits of Limited Liability
C. Evans & Sons Ltd v. Spritebrand Ltd and Another [1985] 2 All E.R. 415 (C.A.) Evans wanted to sue a director of Spritebrand personally, because he had been involved in supervising the company’s actions which amounted to an infringement of a patent owned by Evans. Evans said he was personally liable because he supervised decisions about which scaffolding components they should manufacture, and implemented these decisions. The director said the Plaintiff had to prove that he knew the acts were tortious, or that the individual who carried out the tortious acts was acting as his personal agent, rather than an agent of the company.

Issue: Is the director personally liable for a tort of his/her employer?

Held: He/she may be personally liable, but it is a matter of fact for the trial judge to determine, not a matter of law.

Ratio: 1) A manager must imply, or expressly direct, that certain tortious acts be done, in order for him/her to be held personally liable. (This is a finding of fact, not law.)

2) But for patent infringement, the manager does not need to know that the acts are tortious, since generally that is not a condition of liability for patent infringement, but “must be engaged in the deliberate, willful and knowing pursuit of a course of conduct that was likely to constitute and infringement, or reflected an indifference to the risk of it.” LeDain in Mentmore




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