Lecture 64: Kinds of Business Organization Part 3

Added: 2026-05-10

[00:00:17]Dear learners, we shall be beginning with the part three lecture on the kinds of business organizations.

[00:00:26]In this part three lecture, we shall be examining the legal personality of a company. Now, as you would be able to recall that in the previous part two lecture, we had initiated our discussion on introduction to a company. And in that lecture we had ended on the note of certain core characteristics of a company. The first of which is legal personality of a company. So in this lecture we shall be taking a deeper look as to what do we mean by the legal personality of a business organization in the context of a company.

[00:01:17]So the principle of legal personality is the basic tenate on which the company law is premised.

[00:01:29]It is perceived as the most profound and steady rule of corporate jur prudence and company law.

[00:01:39]So in simple words what it means is that once a company is formed and the legal expression that we used for formation of a company is incorporation of a company the company acquires a separate legal entity which is distinct from and independent of its members.

[00:02:03]So just like uh when a new child is born so the child has a different name different DNA and the child is obviously different from parents although he's born from the parents but he is different.

[00:02:20]So in the same way when certain members they come together and they form a company. So company becomes a legal person who is distinct from the members who actually formed them.

[00:02:37]Now this obviously has certain legal consequences the effect of legal personality of a company.

[00:02:47]So a company has its own name which is separate from the name of its members.

[00:02:55]the company's assets are separate from the assets of its individual members. So if let's say that I have shares in any company like Reliance. So the assets of Reliance will be different and my assets would be different.

[00:03:14]So the assets of the business they belong to the business and they do not belong to the shareholders or members.

[00:03:24]Then a company being a separate legal person has got certain property rights that it has the power to acquire, hold and sell or dispose of property.

[00:03:36]It has the power to enter into contract with other persons in its own name. It has the power to file a case in a court of law or initiate a legal proceeding against other persons. And conversely speaking those other persons can sue the company for any breach of its legal transaction.

[00:04:00]Now another effect of the legal separate legal personality of a company is that the business becomes impersonalized and institutionalized.

[00:04:12]So by impersonalization of business we mean that uh the business does not remain a kind of a personal business of the shareholders although they are the investors and they are the contributors of capital but the business now belongs to a different legal person that is known as a company although it is a artificial legal person but it is a kind of a legal person which is known and recognized by Oh, so the business belongs to the company and not to the members of the company.

[00:04:49]So this is a kind of a legal fiction if we can call it at that. So company is referred to as a legal fiction because it is created artificially by the law and it is not a natural human being. So it is invisible, intangible and it exists only in the eyes and contemplation of law. Being a legal person, it has got many rights, obligations, powers and duties which may be prescribed by the law. So being a legal person it can do most things what a natural person can do except certain acts which require personal execution.

[00:05:40]So thus a company cannot marry or it cannot divorce or it cannot vote in an election so on and so forth.

[00:05:49]So artificial legal person means uh that the legal personality is presumed by law. So we call it a fiction because this is something that does not actually exist in fact. But this does exist in the eyes of law. So factually speaking there is no natural person like a company. It is only a kind of a creation of a law. It is a kind of a hypothesis.

[00:06:22]Now this uh legal personality principle has got statutory recognition under company law.

[00:06:32]So under the company's act 2013 if you refer to section 9 of the act for your convenience and benefit I have reproduced here on this slide. So this lays down what are the legal effects of registration or incorporation of a company. Now according to this provision from the date of incorporation mentioned in the certificate of incorporation.

[00:06:59]So certificate of incorporation is like a birth certificate of a company. When a natural human being is born we know that somebody is born by the birth certificate. In the same way when a company is born the certificate of incorporation is like its birth certificate.

[00:07:16]So such subscribers to the memorandum the subscribers to the memorandum are like uh the founders of the company or the promoters of the company and all other persons as may be the case from time to time they may become members of the company and so company shall be a body corporate. So this expression I have underlined because this is important.

[00:07:43]So by body corporate we means that it is a legal entity that is born by the name contained in the memorandum.

[00:07:53]It is capable of exercising all the functions of an incorporated company under this act having perpetual succession.

[00:08:03]What is perpetual succession? we shall discuss in more detail in the subsequent lectures with the power to acquire, hold and dispose of property which may be movable property or immovable property tangible and intangible to enter into a contract and to sue and be sued by the said name.

[00:08:24]So whatever we discussed in the previous slide as to the powers, rights and obligations of a company, they are given statutory recognition under section 9 of the companies act.

[00:08:38]So a company is called a body corporate because the persons who compose the company are made into a one body. It is like an amalgamation of different persons by incorporating it according to the law and clothing it with a legal personality. The word corporation is derived from the Latin term corpus which means body.

[00:09:06]So now to further explain with clarity and with examples as to what do we known by a legal personality because this is a very important concept related to business organizations whether they have a separate legal personality or not. We'll be taking up some cases.

[00:09:31]Now these cases will illustrate and will give you some real life examples of what are the effects of clothing a company with a legal personality.

[00:09:46]So the first case and arguably one of the most important and landmark cases of company law we have the case of Salomon versus Salomon and company limited a 19th century case of England. So we are referring to the English cases because this rule of legal personality was also laid down in some of the English cases. So we are going to the source of this principle.

[00:10:19]So what I'm going to do is that briefly I'm going to give you the facts of the case. What are the legal issues which emerged from it and then eventually what is the judgment. So to begin with uh there was a person named Salomon who had a successful soul trader business of manufacturing leather boots.

[00:10:41]He formed a limited liability company by the name of Salomon and Company Limited.

[00:10:49]The company consisted of seven financers or shareholders.

[00:10:55]Salomon, his wife, his daughter and four sons.

[00:11:00]Salomon was the managing director and two of his other sons were other directors.

[00:11:08]Thereafter, Salomon sold his business to the company Salomon and Company Limited for almost 309,000.

[00:11:19]Now, as consideration, Salomon received 20,01 shares of£1 each, 8,782 in cash and secured deentures of £10,000.

[00:11:36]His six family members received one share each of£1.

[00:11:42]So essentially speaking all the shareholders and directors they were family members. So it was a kind of a closely controlled business by a family.

[00:11:55]Subsequently, following the economic depression and financial problems in the leather industry, the company's business ran into financial difficulties and the company went into liquidation.

[00:12:10]By liquidation, we mean a process for closure of the company. At the time of liquidation, the total value of company's assets it amounted to £6,50.

[00:12:25]However, its outstanding debts which it owed to its financial creditors amounted to £18,000 out of which 8,000 were due to unsecured external creditors and£10,000 were due to Salomon in the form of secured deentures.

[00:12:48]Now companies unsecured external creditors they realized that nothing would be left for them once Salomon's debts are paid.

[00:13:02]So as a matter of rule in company law. So if the company has taken credit for running its business. So if one set of creditors are secured creditors and another set of creditors are unsecured creditors. So by secured creditors we mean that they have a priority right over unsecured creditors by having a charge on the assets of the company. So if you take a bank loan and the bank loan has certain security of any of your movable or immovable property, it is like a secured citor. So security is there of the loan which has been given.

[00:13:43]So the company's ex unsecured external creditors they became very suspicious and apprehensive that whatever credit they had advanced to the company would not be paid back to them because whatever the value of the assets was there first they would be used to satisfy the claim of secured creditors which is Salomon.

[00:14:11]So these uh external creditors they filed a case against Salomon holding him personally responsible for the debts which the companies owed to them. They further argued that the company was in fact an instrument of fraud or a sham in order to defraud the creditors.

[00:14:41]So here was a case where there was a conflict between the directors and shareholders on one hand and the creditors of the company on the other hand.

[00:14:54]Now to simplify it for you what are the legal issues that emerged from this case. So the first important question was that whether Salomon and Company limited indeed it existed as a company which was separate from Salomon individually.

[00:15:14]The second one was connected to the first question whether Salomon is personally liable to pay the unpaid debts of unsecured external creditors.

[00:15:27]Now to answer the first question, the court held yes, the company was a separate legal entity which was independent of Salomon. It was a real company fulfilling all legal requirements.

[00:15:43]The court further held that once the requirements for incorporation were met under the company law, the company became a distinct legal entity which is separate from the members who formed the company. In this case, Salomon and Company limited became a separate legal entity from Salomon.

[00:16:04]To answer the second question, whether Salomon can be held personally liable to pay the unpaid debts of unsecured external creditors, the court ruled negatively as the business belonged to the company and not to Salomon personally.

[00:16:23]Therefore, the company's debts, they also belong to the company and not to Salomon. Therefore, Salomon was not personally liable to indemnify the company for its debts. By saying so, the court upheld the principle of limited liability of the shareholders. Meaning thereby the shareholders are only liable to the business of the company to the extent of the value of their shares and not anything more than that.

[00:16:56]The court ruled that the shareholders liability was limited to the value of their shares. As such, Mr. Salomon was not personally liable for the company's unpaid debts to the external creditors beyond the amount of their shares.

[00:17:14]So the court essentially ruled in favor of Salomon and disregarded the contention of unsecured external creditors. So this is how and this is what the separate legal personality looks like in law and practice.

[00:17:34]Now to further make it clearer to you we will take up another case another very important case on separate legal personality of a company. The name of the case is Lee versus Leair Farming Limited.

[00:17:54]We will undertake the same exercise.

[00:17:57]Firstly, we'll discuss the facts of the case so that you understand what the case is about. Then we will thresh out the legal issues and finally the judgment of the court.

[00:18:11]So in this case there was a person named Lee. He was a qualified pilot.

[00:18:18]He formed a company by the name Le Air Farming Private Limited.

[00:18:26]This company was engaged in the business of spreading fertilizers on farmland from the air.

[00:18:34]This process in agriculture is known as the process of top dressing.

[00:18:40]Now in this company, Lee owned 2,999 shares of the 3,000 shares in the company and the remaining one share was held by his wife. So there were two shareholders, one Lee and the other his wife.

[00:18:59]He was also Lee's nominee in the company. So if anything happens to the Lee, then his wife would take his place.

[00:19:09]Further Lee in the capacity as the majority shareholder and somebody who was in charge of the business. He appointed himself as the managing director of the company.

[00:19:25]Additionally, he got himself employed as the chief pilot of the company. He was also a manager as well as an employee.

[00:19:34]Now while working for the company unfortunately Lee died in an air crash.

[00:19:40]His widow claimed insurance compensation for the death of her husband in the course of his employment.

[00:19:49]However, to qualify for such compensation, her husband was required to be a worker of the company. Now the company was insured as required for worker compensation under the workman's compensation act 1923.

[00:20:06]However, the wife's claim for insurance was disputed by the insurance company.

[00:20:14]The company opposed Lee's widow's claim for compensation on the ground that Lee's status as the company's director and the majority shareholder. It kind of excluded or pre precluded him from being identified as an employer. So essentially the contention of the insurance company was that how come somebody be the manager of the business, owner of the business and employee at the same time.

[00:20:48]So the insurance company laid emphasis on the fact that they consider him as somebody who is a manager of the business and owner of the business and not an employee. So under the workman's compensation act, the compensation could be paid to workers who are actually working for the business and so they wanted to treat him as a manager and owner of the business and not as an employee.

[00:21:18]Now to identify the issues in this case uh the first question is that whether Lee and the company that he formed that is Lee's air farming private limited would be treated as separate legal entities.

[00:21:37]And then second question connected to the first question is that whether Lee's widow is entitled to get compensation under the workman's compensation act 1923.

[00:21:49]Now to answer the first question, the court held in the affirmative and it held that Lee and Lee's air farming limited were two distinct legal entities despite Lee's significant control and shareholding in the company. It reaffirmed the principle of separate legal entity.

[00:22:16]To answer the second question, the court also held in the affirmative that Lee was recognized as a worker or employee of the company and there was no legal prohibition under the law for the financial or shareholder of a business also to be an employee of the business.

[00:22:35]So as such his widow was entitled to compensation under the workman's compensation act 1923.

[00:22:43]So the court ruled in the favor of Lee's widow and disregarded the contention that was given by the insurance company.

[00:22:53]So in this case the court recognized the existence of valid contractual relationship between Lee on one hand and the company on the other hand.

[00:23:05]In his capacity as the managing director of a company, Lee could on behalf of the company give himself orders in his other capacity of being a pilot and that the relationship between himself as a pilot and the company was that of servant and a master.

[00:23:26]The court observed that Lee's role as company's chief pilot constituted an employment contract that was separate from his diretorial responsibilities and shareholder responsibilities.

[00:23:41]As such, Lee was deemed to be an employee of Lee's Airarming Limited and hence his widow was entitled for compensation.

[00:23:52]Now the court's decision in this case it underlined the importance of assessing the nature of an individual's relationship with a company based on contractual obligation and performance of specific duties rather than solely on the basis of ownership or directorship.

[00:24:14]This case illustrates the application of principles that were established in Solomon's case which we discussed immediately before this case.

[00:24:26]Then we have uh another very interesting case. This is an Indian case. The name of the case is Bacha F. Guzdar versus the Commissioner of Income Tax Bombay. Supreme Court case of 1955.

[00:24:44]Now to give you a brief overview of the facts of this case.

[00:24:49]According to the income tax law, the income of a tea company was entitled to exemption from income tax up to 60% as it was agricultural income.

[00:25:02]The business of the tea company was successful and it distributed profits to shareholders as dividends. So when a company does its business and the business is running well so it gets profits.

[00:25:16]Now this word profit is used generally for businesses but in the context of a company it is referred to as dividends which the shareholders get.

[00:25:28]Now the question was that whether the income that is received by a shareholder in the form of a dividend whether it will be regarded as agricultural income for the purpose of assessment of income tax.

[00:25:45]The Supreme Court uh ruled negatively and it is refused to identify the income of shareholders as the income of the company and reiterated the distinct personality of a company. So in that sense the court differentiated between the income of shareholders as different because they are different legal persons and income of a company as different because it is a separate legal person. So the Supreme Court in this case held that though the income of a tea company is entitled to be exempted from income tax by up to 60% being partly agricultural. The same income when they are received by a shareholder in the form of dividend.

[00:26:32]They cannot be regarded as agricultural income for the purpose of assessment of income tax. It was also observed by the Supreme Court that a shareholder does not as is erroneously believed by some people become the part owner of the company or its property. He's only given certain rights by the law as a shareholder that is to receive notice or to participate in the meetings of the company to vote in the meetings of the company to have a say in how the business of the company is run.

[00:27:09]So the court refused to identify the shareholders with the company and reiterated the distinct personality of the company.

[00:27:19]So with this uh we now come towards the closure of this lecture on legal personality of a company. So in this uh lecture we have discussed what do we mean by legal personality? What are its legal effects?

[00:27:36]When a company is born, it becomes distinct and independent from its members. And then lastly to give effect to some of uh the principles of legal personality, we have discussed some real life cases in order to explain to you in clarity what is meant by the legal personality of a company.

[00:28:03]So although this legal personality of a company is discussed in the context of a company, this is a principle that affects all business organizations like partnership, sole proprietorship, limited liability partnership.

[00:28:20]So this becomes a very important question for the entrepreneur or the persons who form the business as to when they form the business whether it will have a different legal entity or it would be continued to be identified with their legal person.

[00:28:37]Sole proprietorship for example when we'll discuss later it does not have a separate legal entity. So the business is identified by the legal personality of the proprietor who forms the business.

[00:28:52]So all the legal personality is discussed in the case of a company in this lecture but this is something that is relevant for all business organization. That is why I have chosen to devote a individual lecture to this very important concept. So with this we conclude this lecture. We shall be continuing with some of the other characteristics of a company which are again relevant for other business organizations in the next upcoming lecture. Thank you.