‘It is said by many that the juristic controversy over the nature of corporate personality is dead’.Footnote 1
Introduction
UK company law has become misaligned: it has forgotten why companies exist. Not what each individual company's purpose should be – on which a burgeoning amount of material is available.Footnote 2 Instead, we have forgotten why companies attain the special concessions provided to them from the state in the form of a company's separate legal personality and features that flow from it. This paper advances this argument and existing corporate law analysis by reconnecting historic company law arguments to recent developments in economics and political science which run counter to dominant modern company law analysis. It therefore argues that the company's separate legal personality is important, exists as a concession to an economic firm, but that its boundaries and scope have become misaligned to the firm, risking avoidable harms.
The nature of the company's separate legal personality was, between the 1870s and 1920s, a ‘virtual obsession’ in the US.Footnote 3 The debate's crux was, ultimately, whether the company's separate legal personality meant the company was a ‘real entity’,Footnote 4 or a ‘persona ficta’, which existed as a concession from the state.Footnote 5 The debate affects the state's locus to intervene in the activities of the company: if the company is a real entity, then state intervention in its activities is harder to justify than if the company is merely a legal fictionFootnote 6 whose boundaries are set by the state.Footnote 7 This debate was thought to have been resolved in 1926 when a philosopherFootnote 8 pointed out that separate legal personality merely meant whatever law said it did,Footnote 9 but has been revived recently.Footnote 10
In the meantime, economic analysis of corporate law has increasingly become dominant.Footnote 11 Transaction cost economics minimises the role of separate legal personality – arguing that it is, instead, merely a cheaper mechanism to achieve private ordering.Footnote 12 Corporate law literature follows this approach – the contractarian school of corporate law holds that all interactions in respect of the company are, effectively, contracts,Footnote 13 and so considers that separate legal personality merely reduced transaction costs. It is thus trivial.Footnote 14 Even the Law Commission, when exploring whether English partnerships should obtain separate legal personality, considered that it was primarily a convenience (or, perhaps, not having it was an inconvenience).Footnote 15 Corporate personality returned to relevance at the start of the new millennium, with a defence of ‘organisational law’, which separates the assets of the company from the assets of the investor, thus preventing the creditors of the investor from having a claim to the assets of the vehicle.Footnote 16 Similarly, the ability to create a permanent legal personality – which survives the change of all human parts – has been hailed as a vital part of company law.Footnote 17 Nevertheless, separate personality remains downplayed within modern company law commentary. It is thought merely a ‘convenient heuristic formula’ for a combination of features, with ‘no functional rationale’ to provide a more foundational basis for separate legal personality.Footnote 18 Such analysis implies that we should pay no attention to why we grant companies separate legal personality or whether its operation works satisfactorily in respect of any specific rationale.
Yet separate legal personality remains important for four primary reasons. First, as Susanna Ripken's excellent book on corporate personhood demonstrates, law is only one field for which separate legal personality is relevant: it has philosophical and other social science dimensions.Footnote 19 It is thus not only law's to disclaim – legal commentators minimising the role of separate legal personality risk a disconnect between law and complementary fields looking at the same phenomenon. Similarly, such a theoretical approach may lead non-lawyers to misunderstand the effect of the law. Both are to be avoided. As Geldart stated 111 years ago ‘[t]the question is… one which law shares with other sciences, political science, ethics, psychology, and metaphysics’.Footnote 20 Secondly, even within law, it does not merely belong to corporate law. Granting a company separate legal personality places it on a spectrum of law's persons – being all those recognised by law as being capable of holding rights and owing duties.Footnote 21 This thus means that the company's separate legal personality must cohere with other areas regulating the activities of law's persons – for example, criminal law, which has struggled to hold companies adequately to account (with difficulties in attributing mens rea and actus reus to the company).Footnote 22 Similarly, it has been argued that non-companies (often unincorporated associations like sports clubs) should enjoy separate legal personality.Footnote 23 Thus not only is it not only law's to minimise, it is not only corporate law's to minimise. Thirdly, even if separate legal personality is merely a tool to reduce transaction costs, we need to know how good it is at achieving this aim. Fourthly, separate legal personality is a major legal concession to the business community. We therefore need to understand more clearly what this concession provides and why we provide it. As such, it is wrong for corporate law commentators to consider that separate legal personality has limited relevance beyond its practical utility.
Thus separate legal personality remains an important aspect of corporate law. The next issue is why law grants separate legal personality to companies. Vinogradoff demonstrated that there is no fundamental dichotomy between a real entity (a business reality) operationalising by way of a concession from the state (a company), as each company has two sides – real business interactions take place within a state-created legal entity.Footnote 24 He stated that ‘the life of groups has two sides’ – a real business association and an artificial legal form that is provided by the state.Footnote 25 Vinogradoff hints that this occurs in sequence: a real entity is created and then looks to artificial legal tools to operationalise, however it is left implicit and not elaborated upon.
Making this two-step process explicit demonstrates that the two sides of the historic debate were talking at cross purposes. Nearly 100 years ago it was noted that the debate was frustrating because non-legal features were being used to argue legal points – commentators were arguing certain universal statements predicated upon features that did not appear in all companies.Footnote 26 Further, both sides were trying to cater for a different aspect of the realities of corporate law: real entity theorists were, ultimately, arguing that business would find a way through even without a company; state gift theorists were, ultimately, arguing that certain features of corporate life (eg limited liability) only became possible due to rules promulgated by the state. Both were right, merely talking about slightly different things. Reconciling them through a two-step process thus adds clarity to the future direction of corporate law research.
If a company's separate legal personality is a state concession to something real, then what is that real thing? Corporate law analysis assumes that this real thing is the economic concept of the firm. We can think of the firm as a liquid which, to be utilised, needs to be poured into a vessel. Different vessels have different ‘shapes’ depending on their legal features. For example, the differential deployment of limited liability between partnerships,Footnote 27 limited partnerships,Footnote 28 and companies,Footnote 29 can be perceived as features which contribute to different vessel shapes. As the firm needs to deploy legal methods to be able to undertake its activity,Footnote 30 the liquid must be poured into a vessel for economic activity to take place. So long as the volume of the liquid matches perfectly the volume of the vessel there is no issue. This is often assumed – for example, when Jensen and Meckling created the concept of nexus of contracts, they referred interchangeably to this nexus applying to the company and the firm,Footnote 31 arguably evidencing that they were thinking of a single, large public company: if the boundaries of your firm are identical to the boundaries of the company, it does not matter which term you use.Footnote 32 Analysing the company as a two-step process, though, raises the question of which of the two they were envisaging: were they viewing the real business entity as a nexus of contracts, or the state concession of the legal form that it operationalises through?
It is not inevitable that the volume of the two will be the same. The liquid and vessel analogy immediately raises a number of conceptual questions: what is the nature of the vessel before liquid has been poured into it (eg a pre-incorporated shelf company waiting to be tailored)? What is the link between the vessel and the liquid when the volume of the liquid exceeds the volume of the container (eg a multinational corporate group with legal entities in a number of jurisdictions)? What if the pourer deliberately chooses to split the liquid across a number of vessels (eg a private equity holding structure)? Is it conceptually possible for two different liquids to sit within the same vessel (eg a corporate cell structure, with siloed assets and liabilities)? Temporally, what happens if the liquid is subsequently poured into a different vessel (eg an asset sale) and a different liquid is poured into it (eg an existing company which sold its business and became dormant was purchased and a new business run from it)?
These are all methods by which separate legal personality can become misaligned with the firm. Law has the tools at its disposal to align the two, but chooses not to: in fact law facilitates misalignment at every stage of corporate life, starting with law allowing a company to be created without a real entity to be present. Misalignment between the company and the firm causes harms to third parties. Misalignment between the legal entity and the firm has resulted in shareholdersFootnote 33 and certain dominant creditorsFootnote 34 being able opportunistically to maximise their returns and recoveries at the expense of other creditors. Certainly, more complicated group structures are associated with higher ratios of debt to equity overall.Footnote 35 This issue transcends the empirical but instead represents a manifestation of the incentive provided by separate legal personality: procedurally, UK companies are established by shareholders and directors.Footnote 36 Thus misalignment of the corporate form from the business reality will only occur when the ultimate shareholders and directors of the top company consider that misalignment would be beneficial for them. This is not to say, of course, that misalignment invariably causes harm to third parties. However, it provides an opportunity for pre- identified incentives for two key corporate constituencies to manifest to harm third parties. Company law itself has increasingly retreated from its role in mitigating such manifestations, and has increasingly left it to other areas of the legal taxonomy to remedy company law's mistakes. This is untenable. As the corporate form is a concession from the state to the firm, the potential for self-serving misalignment between corporate form and the real entity that it exists as a concession to is a mistake that should be remedied. Historical company law, and current partnership law, provide a series of legal tools which could be deployed for this purpose, and they are explored in this paper.
The step forward taken by this paper, then, is making the two-stage process that Vinogradoff alludes to explicit and exploring its implications. The author's contention is that the state concession of the modern company exists for real business entities. We thus develop currently prevailing ideas that the company is created by the activities of the stateFootnote 37 by exploring why such state concessions are provided. In doing so, this paper develops our existing legal understanding of the company. It builds on Ripken's notion that the company's legal personality is too complicated for a simple, one-stage interpretation.Footnote 38 This provides a conceptual development for company law – fusing together the advantages of the real entity theory and of the concession theory to produce a holistic unified approach which resolves recurring debates. This approach provides a normative claim for UK company law: that law provides companies as a concession to the business community. As such, we must ensure that the extent of this concession meets policy objectives without causing disproportionate harms. This provides a greater locus for the state to be able to curtail activities of companies which appear to cause societal harms. By foregrounding law, then, in the analysis of the company we understand more clearly the role that law can play in remedying problems it has created and facilitated.
The rest of this paper proceeds as follows. Section 1 explores separate legal personality: the historical debate and modern discussion. Section 2 explores the economic concept of the firm. Section 3 explores misalignment between the two – problems of misalignment, how law provides spaces for temporal misalignments, and misalignments in scope, and legal methods available to undo such misalignment. The paper ends with a short conclusion.
1. The concession of separate legal personality
We start, then, with the nature of separate legal personality, which we shall see is a state concession to a real entity. Under Roman law, human individuals only had separate legal personality if they could sue and be sued, and some non-natural persons enjoyed the same privilege.Footnote 39 The nature of a group's ability to sue and be sued was inherently linked to prevailing political attitudes to freedom of association.Footnote 40 However, Roman law concepts do not neatly map onto modern understanding of corporate separate legal personality, and thus cannot really be analogised.Footnote 41
The modern debate began under German law at the time of German unification.Footnote 42 It is here that attention was brought to earlier views of Pope Innocent IV, Pope between 1243 and 1254, who thought that only humans could be excommunicated:Footnote 43 as ecclesiastical bodies were mere fictions,Footnote 44 they could not.Footnote 45 This argumentation structure remains in modern day secular analysis – often predicated on the idea that a company has no single mind, making it harder to hold the company to account for wrongdoing under criminal law.Footnote 46 The fiction argument, though, did not exist as a single school of thought but was actually two arguments. The first strand was that the legitimacy of the company arises from the authority of the state. The second strand was that the interactions arising in respect of the company were purely imaginary – legal recognition of a company was purely an ex post method of rationalising interactions between humans who solely considered themselves dealing with other humans.Footnote 47
The second strand was quickly dropped. Savigny stated that ‘[w]e now have to consider it (juristic personality) as extended to artificial subjects by means of pure fiction’,Footnote 48 and believed in ‘the necessity of State sanction for the creation of every legal person’.Footnote 49 It is here that we start to see the voluntary surrender of the ‘fictitious’ aspect of the fiction theory as artificial does not equate to fictitious – indeed they were viewed by corporate law authors as dichotomous:
a corporation cannot possibly be both an artificial person and an imaginary or fictitious person. That which is artificial is real, and not imaginary: an artificial lake is not an imaginary lake, nor is an artificial waterfall a fictitious waterfall.Footnote 50
Savigny's adherents would agree: something real needs a legal mechanism to operate through, and this is the artificial creation of the company.Footnote 51 The issues arise when commentators conflate the company and this real thing. Often, even where this conflation is avoided, commentators have assumed that this real thing is the sum of the individuals behind the company, or merely an aggregate of their interests.Footnote 52 However, this ignores an important aspect of group dynamics – individuals can decide to act as a group before choosing the group's legal form.Footnote 53 There is thus something between a mere aggregation of individuals and the company – individuals must decide to act as a group, then that group must decide to use a corporate form. The company is, at the same time, artificial (as it is using a legal form provided for by the state) and intended to be the operationalisation of something real. It is not contradictory to state that something real operationalises through something artificial. The fiction theory, then, dropped the eponymous aspect of its name. What is left is the notion that the company's powers arise from the legitimacy of the state: in particular, that the precise legal calibrations of the company are decided by the state.Footnote 54
The fiction theory's scope thus narrowed. Expositions of the ‘fictitious’ part of the fiction theory fell away. It became more of a straw man to be argued against, without many strong adherents. It is mostly espoused by those wishing to disagree with it. As such, it is dangerous to interpret the fiction theory by reference to what those disagreeing with it hold it out to be. It was in response to the ‘prevalent’ persona ficta theory that Gierke's concept of the corporation as a real entity was developed.Footnote 55 Thus Gierke stated strongly that, as Maitland's translator's introduction reads, a company ‘is no fiction… no piece of the State's machinery… but a living organism and a real person, with body and members and a will of its own’.Footnote 56 This twists the narrow focus of the fiction theory. The argument is not that the company is part of the state, but that the company's personality arises by concession from the state. The former seeks to adopt the company as part of the operations of the state, the latter merely notes that it arises by reference to the state's gift. Maitland was thus slightly misrepresenting the main aspect of the fiction theory: the state gift, or concession, aspect.
Gierke's ideas were promoted in England by Maitland and Pollock. Maitland's defences were strong,Footnote 57 but Pollock was the most strident. Pollock argued that English law had rejected the ‘most important consequence of the Fiction theory’, that a company only has the capacity that is expressly conferred upon it. Pollock argued that the court had a number of opportunities to limit the activities of the company, and had failed to, actively interpreting the charter of a company widely.Footnote 58 Pollock does not refer to the list of things that a human can do that a company cannot,Footnote 59 making his argument not quite complete. He goes on to state:
Such is the normal use of legal fiction, not, as the vulgar suppose, to escape from the truth of things, but to make room for it by the recognition of pressing facts. In form it may be, and generally is, transparent; but no one is expected to accept it literally.Footnote 60
We again see here a way to reconcile again the two sides of the argument – fiction theory does not need to accept that the company is an actual fiction. Indeed, corporate law's use of the term ‘legal fiction’ in debates is different to law's normal understanding of the term. Normal legal analysis tends to use legal fictions as an analogy – a fiction is used so that something that is manifestly not present is deemed present in order to create a just outcome – for example implied terms in contracts.Footnote 61 As Fuller stated ‘judges and writers on legal topics frequently make statements that they know to be false. These statements are called “fictions”’.Footnote 62 These statements are not believed.Footnote 63 Corporate law's fiction approach is different, in that it merely considers the boundaries of the company as being set by law – the state gift aspect of the fiction theory.
The state's role in setting such boundaries is evident in two clear examples. First, despite contractarian claims to the contrary,Footnote 64 under English law limited liability for shareholders in companiesFootnote 65 requires a statutory footing to be provided by the state.Footnote 66 Secondly, separate legal personality itself is an inherent concession provided by the state through incorporation. Incorporation is the ‘mysterious rite’ of creating a new corporate person.Footnote 67 English law has long held that there can be no incorporation without ‘the King’, or the operation of the state.Footnote 68 This remains the case today.Footnote 69 There is no dichotomy in acknowledging that real entities exist, and that the state gifts them a legal body to operate within. Radin argued that the realness of human persons and the artificiality of corporate persons are both overstated,Footnote 70 once more bringing the two positions closer together than acknowledged by Pollock. Certainly, Gierke overstated his argument. The above quotation from Maitland refers to the company as being a living organism and a real person. As Gindis stated:
There is something suspicious about Gierke's theory because it transforms what could in some respects be deemed as an interesting analogy between associations and human beings into something more. It is one thing to claim that when the bond of association is strong a group of human beings can be properly described as a singular decision-making unit. It is quite another to argue that the group is physically a living unit.Footnote 71
Accepting this valid criticism means that as the fiction theory rows back to state gift aspects, the real entity theory also rows back – acknowledging instead that there is a single unit, rather than a biological organism. A two-step process reconciles the two positions. A group forms a real singular unit for decisions, and it then uses the state gift of the corporate form. Vinogradoff foreshadowed this argument in 1924. He stated
There are two sides to be considered in the case of companies and corporations. There is the business side directed towards a material purpose, which is created, not by the law, but by the respective interests involved. On the other hand, there are the legal consequences attached to the association, which may amount to the appearance on the scene of a new ‘juridical person’.Footnote 72
Vinogradoff thus focused on a dual aspect of the company. This is easily extended to a two-step process – a group of individuals come together for a business purpose, and form a business association. They then operationalise that through legal means. The former is a natural, or real process. The latter must use legal tools available. This includes company law. Vinogradoff hinted at this in the above when he referred to the legal consequences attaching to the association, implying that association is the precursor to legal consequences. By embracing this two-step process and making it more explicit, we can gain further clarity into the optimal operation of companies and company law. Thus whilst the company remains a way for the real entity to operationalise, the company itself is not a real entity. It is a concession from the state to allow the real entity to operate. The two-step process is implicit within both historic arguments: from the concession side, there must be a concession to something – implicitly something real. From the real entity side, the company is clearly established by the state and it cannot be down to the state to create the real entity – otherwise such real entity relies more heavily on the state than even concessionists would argue. Thus the two-step process demonstrates that the two sides were actually arguing at cross purposes.
Were the concession of corporate personality not present, market participants would find other ways to allow the real entity to operationalise. If incorporations of new companies were banned, business activity would continue to take place through different legal methods.Footnote 73 Similarly, a new form of business entity will not dramatically increase business activity.Footnote 74 At the margin, the increase/saving of transaction costs involved may be determinative as to whether the real entity is operationally viable.Footnote 75 This shows the two-way interaction between the real entity and the legal concession.
Vinogradoff's insights were overshadowed by Dewey's two years later that separate legal personality merely meant what the law made it mean, and that at its core it merely meant that a company was a right and duty bearing unit, ‘the constant unit in the logic of a legal system’.Footnote 76 Nékám further argued that we needed to disaggregate conceptually being a right and duty bearing unit from the administrator of such rights and duties.Footnote 77 Nevertheless, the fundamental ‘dual nature’ insight is important as it is sequential in nature – the decision to act as a group is taken separately and conceptually prior to the decision as to the organisational form that such group will take. This lets us resolve these long running debates – something is real, and the state's concessions provide the operational form to that something. Importantly, it is not the company itself that is real – that is simply a legal form that the real thing utilises. As Smith stated in 1928, separate legal personality facilitates and regulates conduct.Footnote 78
We thus need to de-couple the conduct itself (for companies, traditionally agreement to act as a group for profit), from the operationalisation of that conduct through the legal form. Extreme forms of fiction arguments were unpersuasive because they denied that real activity took place. Extreme forms of real entity arguments were unpersuasive because they denied that state gifts were involved in company life. Extending Vinogradoff's insights lets us fuse the two: the company exists primarily to allow something real a way to operationalise, via the state gift of the company.
However, the legal tools that allow such operationalisation do not require a real entity to be present. Thus whilst the company may exist as a concession to something real, it can be established without something real. There is thus a risk of a false syllogism: the company exists for something real, but that does not mean that every company represents something real. Law has the tools available to make such an alignment between the legal form and real entity, yet does not deploy them. This is discussed further in Section 3 below, but suffice to note here that one person can form a company,Footnote 79 and no additional shareholders are required later.Footnote 80 This undermines the pure version of the real entity theory, as there is not always something real behind the company. As such, Maitland (in the real entity tradition) denounced the corporation soleFootnote 81 as being an aberration to corporate theory.Footnote 82 Liberalisation of minimum shareholder numbersFootnote 83 thus poses a major challenge for the pure version of real entity logic. In the modern day, we do not need group activity to set up or run a company, meaning that ‘the boundaries of organizations do not have to align with the boundaries of the corporate form’.Footnote 84 The paradigmatic use of a company is as a legal tool through which a real entity can operationalise. No extra-human real entity, though, is required as a prerequisite to create or operate a company. Corporate law has de-tethered from the two-step process that tacitly underpins corporate law theory. We shall argue later that this causes avoidable harms and requires remedy.
2. The firm
We must look beyond the company, then, to establish the real thing that the company exists as a concession to. Understanding this will help us ascertain whether the boundaries of the concession of company law are appropriate or not. In economics, the real thing that companies exist as a concession for is known as the firm. The firm was raised by a number of historical commentatorsFootnote 85 but became foregrounded by the 1930s.Footnote 86 In particular, in 1937 Coase argued that there were costs of going to the market (what we would now think of as transaction costsFootnote 87) that can be saved by bringing such activity into the firm, thus replacing market risk with internal authority.Footnote 88 Thus the firm is set up as a form of collective activity; the dichotomous alternative to the market.
There are also associated costs of such authority – including ensuring that work is undertaken by insiders whose output is variable but whose income from the collective endeavour is fixed.Footnote 89 This focus on economic forces within the firm resulted in the blurring of the edges of the firm,Footnote 90 with some commentators talking of a continuum between the market and the firm, with it being possible to conceive of a hybrid between the two.Footnote 91 This led to a lack of certainty over what the core characteristics of the firm were – for some, it was control,Footnote 92 for others co-ordination about the joint outcome of a team,Footnote 93 for some joint property.Footnote 94 Unfortunately, most expositions of the firm say ‘very little about the firm. The problem is that there are really no firms in these models, just representative entrepreneurs’.Footnote 95 It has been argued that the firm is too complicated for one single model,Footnote 96 with Machlup identifying at least 21 different usages of the term.Footnote 97 Hart stated:
[m]ost formal models of the firm are extremely rudimentary, capable only of portraying hypothetical firms that bear little relation to the complex organizations we see in the word. Furthermore, theories that attempt to incorporate real world features of corporations, partnerships and the like often lack precision and rigor.Footnote 98
Others have argued that this means that there is no point trying to define a firm,Footnote 99 or that any definition would be arbitrary.Footnote 100 However, our understanding of the firm is important – the boundaries of the firm have a series of other knock-on effects, such as the boundaries of corporate finance.Footnote 101 Similarly, we must understand the firm to understand the legal limits of the concession made by the state to it – the company form. Hodgson argued that there was little development on the theory of the firm from 2000 to recent years.Footnote 102
This changed in 2017, when Deakin, Gindis, Hodgson, Huang and Pistor advanced the understanding of the firm considerably in economic literature.Footnote 103 They argued that firms ‘have to be treated as creatures of the law’.Footnote 104 Further,
[t]hese puzzles concerning the nature and identity of the firm are solved once we recognize it as a legal entity. The glue that holds the firm together consists of the legal provisions that bind the parties into one legal entity, and in turn draw on appropriate legislation.Footnote 105
Thus the boundaries of the firm are replaced by the legal boundaries identifiable. This has been objected to by Robé on the grounds that ‘firms are structured using corporations; they are not corporations’.Footnote 106 For Robé, the economic concept of the firm and the legal concept of the company exist in different universes.Footnote 107 If matters stopped there, then we would simply have further alternative conceptions of the firm to add to those outlined above. However, the debate has been ongoing. In 2021, Deakin, Gindis and Hodgson (DGH) replied to Robé.Footnote 108 They argue that it is common for legal articles to refer to companies and firms interchangeably.Footnote 109 They reiterated the definition advanced in 2017 that a firm is ‘individuals or organizations with the legally recognised capacity to produce goods or services for sale’.Footnote 110
DGH refer to a number of areas of agreement with Robé. They argue, though, that the legal form dictates economic activity, such that ‘[t]he law of the business firm… is so deeply imbricated with the operation of firms in the economy that it makes no sense for the economist's conception of the firm to ignore the law; hence our claim that a productive entity which is not “legally structured” is not “in economic or other terms, a firm”’.Footnote 111 This, then, doubles down on the insight that legal rules are important to the firm. It goes further, and argues that firms require legal structuring. This does not mean, though, that there is an inevitable overlap between the company and the firm: special purpose vehicles are set up as companies, but are not firms.Footnote 112 Similarly, firms do not only structure by way of legal entity – also by reference to partnerships.Footnote 113 It is also not inevitable that each company within a company group structure is its own firm.Footnote 114
Robé replied again, reiterating his claim that the company and the firm are two totally different concepts.Footnote 115 DGH have responded yet again to evidence common synonymy between the firm and the corporation.Footnote 116 They go further and argue that legal form is a requirement for a firm – thus ‘all corporations are firms, but not all firms are corporations’.Footnote 117
DGH were writing for an economic audience, arguing that legal form is important to economic analysis. They are therefore less concerned with legal delineation. Thus whilst they consider every corporation to be a firm, they do not mean that every company is a corporation, nor that a corporation can only consist of one legal entity. For DGH, a corporation is a type of company that is undertaking firm activity. As such, not every company falls within the term corporation as used by DGH. They state of special purpose vehicles and passive asset holding vehicles that ‘[t]hese companies are not firms in any real sense of the term, and our definition of the firm as a legally constituted entity set up for the production and sale of goods and services does not require us to treat them as such.’Footnote 118 Similarly, within groups, DGH note that ‘regardless of the country in which it is incorporated, a national subsidiary of a multinational enterprise may well be operating as a singular firm’.Footnote 119 The use of ‘may’ indicates that whilst there may be multiple firms within a multinational corporate group, it is not inevitable and automatic that there will be – it is instead a question of how each subsidiary is used. As such, separate legal personality is an important aspect of the firm, but not exclusively determinative of its boundaries – firms can be split across multiple legal persons, and a separate legal person can exist without a firm. Whilst the company's separate legal personality exists as a concession to the firm, there is space for the boundaries of the company's legal personality to misalign with the boundaries of the firm.
Beyond separate legal personality, the firm has further implications for corporate law analysis. First, the terms company and firm are frequently used interchangeably.Footnote 120 This is often unreflexive – not an overt argument that the boundaries are the same, but a tacit assumption that the two perfectly overlap.Footnote 121 Secondly, where this is avoided, for example in comparative company law, the firm is used as a jurisdiction-neutral term, to refer to a wider concept of which a jurisdiction's specific legal vehicles form part.Footnote 122 Thirdly, arguments about the design or reform of corporate law tend to be based on conceptions of the firm.Footnote 123 Space for misalignment, then, between the boundaries of the company and the boundaries of the firm cause risks for corporate law analysis.
3. The misalignment of corporate law
(a) The problems of misalignment
So the company's separate legal personality arises as a concession to the firm. Companies and their separate legal personality accordingly ‘transgress all the basic dichotomies that structure liberal treatments of law, economics and politics’.Footnote 124 Political science has recently focused on the concession provided of the corporate form.Footnote 125 This concession is not provided to every group who wish for it.Footnote 126 It is provided because society expects to receive overall benefits from allowing the incorporation of companies, particularly wealth generation across wider society as a whole.Footnote 127 It is also, though, associated with real societal harms. These harms are often flagged in respect of limited liability,Footnote 128 particularly the deployment of strategic liability within the corporate group.Footnote 129 These, though, are merely a manifestation of the bigger issue that misalignment between company and firm can be manipulated by certain constituencies for personal gain to the detriment of other constituencies. It is therefore logical that the state should be able to provide limitations on the gift that it provides to be corresponding to its benefits. State locus to do so becomes evident when we acknowledge the role of the state in granting the concession that provides certain constituencies with the means to cause harm to other constituencies.
Corporate separate legal personality exists for a real entity of a firm.Footnote 130 Yet UK company law creates a number of opportunities for such legal personalities to be created without a corresponding real thing being there, and does not limit each real thing to only having access to one legal person. Law therefore allows a misalignment between the legal form and the organisational form.
Allowing a concession for a firm does not, of course, automatically mean that each firm must only receive one concession. However, there are harms associated with multiple concessions and misalignments of company and firm. Specifically, it has been argued that such misalignment can be a deliberate ploy to maximise leverage to excessive or unsustainable levels within the group,Footnote 131 undertaken by directors at the behest of shareholders (or in response to pressure from them), or in cahoots with major creditors.Footnote 132 This can be seen, though, as part of a more general point. We know that corporate law incentivises shareholders to utilise the corporate form to maximise their own income at the expense of third party creditors.Footnote 133 We also know that there is a concern that directors will maximise their own income at the cost of others.Footnote 134 Yet it is precisely these two constituencies who drive misalignment between the firm and the company.
Conceptually, it has been argued that these two constituencies take decisions as to the structuring of legal form.Footnote 135 It is also doctrinally the case in the UK: a new company is set up upon processing of a form signed just by shareholders and of directors.Footnote 136 We can thus assume that ultimate shareholders (ie the shareholders of the parent company) and directors will only create the misalignment of the legal form to the organisational form if they perceive some personal benefit to them which would not otherwise be available. Unsecured creditors who cannot adjust the price that they interact with the organisation with (be they voluntary creditors without the power to adjust, or involuntary creditors whose interactions with the organisation are not of their choosing at all) are less likely to know about organisational structure. Whilst the claim of each individual such creditor may be small, in aggregate they are likely to add up to a material quantum of claims against the company.Footnote 137 It is thus rational for directors and shareholders to use their knowledge and power to structure the legal operation of the firm in the way that diverts (or provides the most opportunity to divert) funds from such non-adjusting unsecured creditors to directors and shareholders. Such methods of diversion would not be possible if the boundaries of the legal form automatically aligned to the boundary of the firm, as then creditors to the firm would have access to all the firm's resources. Mandatory re-alignment would protect, for example, asbestos miners from the use of a smaller overseas subsidiary to shield the main assets of a global firm from risk of damages claims.Footnote 138
The misalignment between legal form and the firm is something that other areas of the legal taxonomy are acutely aware of and actively dealing with. Various other areas of the legal taxonomy, such as tort law,Footnote 139 and competition lawFootnote 140 provide mechanisms for ensuring that liability applies to all legal vehicles within a firm. Yet company law does not. Indeed, company law has retreated in this regard – the concept of piercing the corporate veil which used to be company law's method of resolution of part of the issueFootnote 141 has been considerably weakened.Footnote 142
It is tempting to view this as the optimal operation of law: company law establishes a legal framework in which such misalignment is possible, and other areas of the legal system act to mitigate any harms caused by such misalignment.Footnote 143 However, there are three reasons why such analysis should be rejected. First, it ignores the incentives that are faced by directors and shareholders, which are to export such risk as possible to nonadjusting unsecured creditors.Footnote 144 The operation of other areas of the legal system require some form of actionable wrong to be undertaken to provide a remedy. Not all loss suffered by such nonadjusting creditors as a result of misalignment will result from an identifiable wrong – company law incentivises strategic deployment of separate legal personality to the repeated advantage of only parent company shareholders and directors. As such, this analysis admits that harm will be caused by the use of the corporate form, and only the most egregious of it will be prevented. In light of the foregoing conclusion that the corporate form exists as a concession to the business community, this seems an inadequate counter-concession to obtain.
Secondly, it starts from the default position that company law allows misalignment, then leaves it to other areas of the legal taxonomy to decide when this should be ignored. This is an abrogation of responsibility from company law. We consider it axiomatic that companies cannot marry or have children.Footnote 145 It is for private law to establish that a company cannot do this. It is not unreasonable, though, to ask that corporate law provides: (a) an acknowledgment that there can be limitations on separate legal personality; and (b) a thorough understanding of such for other legal disciplines to work from. Only then can subtle questions, like whether a company should enjoy human rights,Footnote 146 be fully explored. Similar issues arise in criminal law.Footnote 147 Particularly, it has been argued that existing discussion within the criminal law field of the ‘Scottish laundromat’ of abuse of Scottish limited partnershipsFootnote 148 misses nuances of the Scots law rules in respect of separate legal personality.Footnote 149 This illustrates a much wider point: it is unsustainable to uphold a limitless freedom for only directors and shareholders to choose the boundaries of separate legal personality. Company law's attempts to uphold such a position requires non-corporate lawyers (eg tort lawyers) to establish where separate legal personality should be ignored. They can easily miss nuances. Corporate law therefore cannot leave matters to other areas of the legal taxonomy to resolve and should, itself, provide limitations on the misalignment of the corporate form and the firm.
Thirdly, we have argued that separate legal personality is a concession from the state to a real thing. Given that there are potential societal harms caused by misalignment between the legal form and the firm, the default position should be that the legal form is provided for a real thing, and each real thing only has access to one legal form to operate through. Unfortunately, UK company law has repeatedly refused to remedy this alignment, and has in fact facilitated it. The rest of this section explores how law allows and facilitates two different types of misalignments between the company and the firm which can cause such harms: temporal misalignments and misalignments in scope.
(b) Temporal misalignments
It was open to the legal system to stipulate that incorporation was only available to proposed actual business associations, and then they could only access one. Company law has not chosen to do so. There are very few requirements to set up a UK company – merely someone to act as a director, some person to act as a shareholder, a name, a constitution (the default will apply in the absence of stipulation), filling in the relevant form and the payment of the relevant fee.Footnote 150 A large number of companies are incorporated by formation agents, sitting on the ‘shelf’ until acquired by a business. These pre-incorporated companies tend to be incorporated in batches, all with the same directors, shareholders, constitutions, and names with only one sequential number difference. Each is certainly a company. They have, though, done nothing yet. They are only associated with business activity as a fungible commodity of the formation agent's to sell: the object of business activity rather than its subject. Company law, then, requires no ‘real thing’ in existence to allow this concession to exist. Requirement of more than one individual to have genuine, substantial involvement in the business was precisely one of the concepts raised in the famousFootnote 151 company law case of Salomon v Salomon,Footnote 152 and rejected. UK company law used to contain more formal requirements which acted as proxies for the presence of a real thing, but these have been gradually rowed back.Footnote 153
In the same way that the incorporation process does not require more than one person (therefore no distinguishable ‘real thing’), it does not require any activity to be in active contemplation. Once again, there is no legal inevitability in this: partnership law provides a model to link the commencement of the vehicle to undertaking business activity.Footnote 154 No incorporation, of course, is necessary to create a partnership, but a hybrid model is entirely possible in which either something real must be a precursor to incorporation, or the company existed from the later date of its incorporation and intention to undertake business activity. Not only do companies exist without a real thing (either shelf companies or one-man companies), but they have, as a matter of company law, the same personality as the largest traded companies. If we consider the real thing company law requires to be a liquid, and the corporate form to be the vessel into which the liquid needs to be poured to be utilised, these shelf companies are akin to vessels into which no liquid has yet been poured. They retain the same capacity to hold liquid, but have not yet received any. They have become de-tethered from the two-stage process: the concession is available without something real having to underpin it. This demonstrates further that the legal form of the company cannot automatically on its own be seen as any form of ‘real entity’.
Temporal misalignments are not limited to the start of the company's life. They also exist upon change of corporate participants and the cessation of business activity. The company's primary advantage over other business formsFootnote 155 is that it transcends changes for individuals involved in the business. The identity of shareholders, directors, employees, and underlying business can change – but the company continues. The example has been used of football clubs – a company could own one football club, sell it, change directors and shareholders, and purchase a different football club.Footnote 156 The company, as a matter of company law, is the same, even though the ‘real thing’ it operates changes. The author has argued elsewhere, in the context of the liquidation of the company that held Rangers football club in Scotland, that this exposed the dangers of focusing too closely on the legal limits of organisational form:
if OldCo sold Rangers to NewCo, but instead of being liquidated OldCo then bought the Italian football club SS Lazio, we would not believe that, in some way, SS Lazio had won any Scottish football titles even though the same legal person would technically have done so.Footnote 157
The company continues even if the change is sudden. For example, if there is a corporate acquisition, directors will often resign on the same day as the shareholders change. If at the same time all liabilities were paid, all assets distributed to remove all distributable reserves and assets, all employees were terminated, the name of the company changed, and the company changed its business entirely: the company would still be the same despite the firm shedding it.
This misalignment is harmless if the creditors are paid off fully. However, that is not always the case. This is especially so in pre-packaged administrations,Footnote 158 where the business of the firm is often transferred to another legal entity, often with linked major creditors, directors and shareholders, and unsecured creditors in the old vehicle are left behind.Footnote 159 This lets the firm continue whilst jettisoning legal forms and harming unsecured creditors. Some legal protections exist in respect of this risk – phoenix company legislation provides that someone who is a director of a company in the 12 months up to it entering insolvency cannot be the director of a company which is known by that name or a similar name within five years.Footnote 160 This focuses on names, though, rather than underlying business activity. There are also insolvency practitioner requirements to ensure that there is fairness to the unsecured creditors of those left behind.Footnote 161 These, though, merely provide a series of steps for the insolvency practitioner to take to try to maximise the value of the business in the sale, rather than letting creditors to the firm follow it to a new legal entity.
Once more, this is not a legal inevitability. Scottish partnership law has created a model whereby if assets are transferred from one partnership to another, it is presumed that related liabilities are also transferred.Footnote 162 Introducing such a rule to corporate asset sales would help mitigate the harm of creditors being left behind, by aligning the legal form to the firm.
Requiring something real (in terms of number of participants and intention to undertake business activities) at the start of the company, and preventing the firm from leaving creditors behind in the old company whilst it continues, would align the company to the firm temporally, so reducing the manifestations of the systematic abuse of opportunistic misalignment noted above. Existing legal tools can be deployed to mandate such re-alignment.
(c) Misalignments of scope
Misalignments can also occur contemporaneously. This is most commonly seen within company law's perennial conceptual problem – corporate groups.Footnote 163 Here, the liquid is split amongst a number of vessels. The situation arises in two particular contexts. The first is where a company has a number of subsidiaries. This is common many in industries – for example in the property owning industry property sales taxes are higher than share sales taxes,Footnote 164 meaning that transaction costs are lower in selling the shares of a company that owns a property compared to selling the property itself. It is therefore usual for property owning groups to have one holding company (which may provide central services to the others), which owns the shares in other companies, each of which only owns one property and contracts with the holding company. Here, the firm is split over many corporate entities. As noted above, the decision to misalign the corporate boundaries from the firm is undertaken by the ultimate shareholders and directors of the top company, based on what is likely to maximise their income. This is the tool deployed famouslyFootnote 165 in the New York case of Walkovsky v Carlton,Footnote 166 where Carlton's business owned 20 taxies split across 10 companies, each owning two cabs. When one cab negligently struck Walkovsky, he was only able to obtain recourse against the two taxis held in the one company (Seon Cab Corporation) which owned the taxi that hit him.
Secondly, it is common in corporate acquisitions (especially in the private equity market) to establish a series of new companies to act as holding companies at the top of the corporate chain, to distance ultimate shareholders from the ultimate business.Footnote 167 The same issues arise (the real entity's liquid is split across multiple operational vessels). However, whilst the former example can be dismissed as the creation of a subsidiary (sometimes called a special purpose vehicle) which is somehow lesser than a typical company and therefore to be treated differently,Footnote 168 the insertion of a holding company provides different challenges. It is not the case that the trading aspects of the business have been segregated, but the holding aspects.Footnote 169 Again, the features of business activity remain the same, as do owners and managers.
These misalignments represent the archetypical problems of misalignment – in the former, liability is kept away from assets or risks to third parties increased by business practice, and in the latter excessive leverage is facilitated. Once more, company law had tools to mitigate this, but rejected them. First, it was entirely possible for company law to hold that companies could not hold shares in other companies, yet this was rejected.Footnote 170 Secondly, law had tools to apply liability to shareholders in one-man companies, thus undoing the advantage of corporate groups. These have been rowed back over time,Footnote 171 segregating liability within a group context.Footnote 172 Thirdly, automatic cross-liability within corporate groups as a matter of company law has been rejected under UK company law.Footnote 173 Fourthly, as outlined above, company law tools to apply liability in specific situations within company groups have retreated, leaving this to other areas of the legal taxonomy as noted above, with the risks outlined above.
These failures to align the boundaries of business entity to the boundaries of the firm represent a failure of company law. The company exists as a concession from the state for business activity to promote a public good. However, it comes with risks of opportunism. Misalignment exacerbates these risks, and company law should deploy the available tools set out above to remove such misalignment.
Conclusion
This paper has argued that corporate separate legal personality arises as a concession to something real. That real thing is the firm. However, there is a misalignment between the two concepts. This misalignment is ripe for abuse by those who pick the boundaries of legal forms – ultimate shareholders and directors. Further, there is evidence that misalignment has been abused and analytical grounds to believe that it is structurally likely to be abused.
Company law has consistently rejected attempts to align the extent of the business entity to the extent of the firm. Temporally, company law rejected requiring a real thing, or even an intention of a real thing, from being a prerequisite to the establishment of a company, and it fails to ensure that liability tracks the firm. In terms of scope, corporate groups have become possible with segregated asset and liability pools. Both methods of corporate group creation – new subsidiaries and new holding companies – create risks (segregating liabilities and excessively financialising assets, respectively). Once more, company law has failed to align these boundaries.
This is a material failure for company law. It means that the corporate form is de-tethered from the two-stage process that the company is created for. Company law cannot continue to leave other parts of the legal taxonomy to remedy this error, and needs to remedy it itself. By drawing on historical UK company law tools and existing partnership law tools, company law can align the boundaries of the company to the boundaries of the firm. This will provide the concession intended to the firm, whilst mitigating some of the risks of harm emanating therefrom.
