Consequences of Incorporation

The main result of incorporation is the creation of a company as a separate legal or artificial
personality distinct form the natural members. The company acquires corporate capacity and
from this result flow other consequences, namely:
1. The company is liable for its debts: this rule was established in the case of Salomon v A
Salomon & Co Ltd [1896] UKHL 1, [1897] AC 22:
Facts
Salomon was a successful leather merchant running his business as a sole trader. He formed a
company and transferred his business of boot making to the company (Salomon & Co. Ltd.),
incorporated with members comprising of himself and his family. The price for such transfer was
paid to Salomon by way of shares, and debentures having a floating charge (security against
debt) on the assets of the company. But one year later, the company was liquidated, and the
assets available were just enough to pay Salomon as the secured creditor of the company. The
liquidator argued that Solomon and the Company were one and the same, and therefore Salomon
was personally liable for the debts of the company. The Court of Appeal agreed with the
liquidator, declaring the company to be a myth, and that Salomon had incorporated the company
contrary to the true intent of the then Companies Act of 1862, and that the company had
conducted the business as an agent of Salomon, who should, therefore, be responsible for the
debt incurred in the course of such agency.

The House of Lords on appeal, reversed the above ruling, and unanimously held that, as the
company was duly incorporated, it is an independent person with its rights and liabilities
appropriate to itself, and that “the motives of those who took part in the promotion of the
company are absolutely irrelevant in discussing what those rights and liabilities are”. Thus, the
legal fiction of “corporate veil” between the company and its owners/controllers was firmly
created by the Salomon case.
2. While the company’s liability for the debts of the company are limitless, meaning that
company properties may be ceased and sold to settle the debts of the company, the
liability of members for the debts of the company is limited to the unpaid shares of the
members. This means that upon liquidation, if members acquired shares and have not
paid for them, their properties may be ceased to settle that balance. But if they have for
their shares in full, then their liability for the debts of the company is extinguished and
they owe the company nothing. This is the meaning of the concept of limited liability.
3. A company can own property in its own name and members do not have proprietary
interest in this property. This rule was established in Macaura v. Northern Assurance Ltd
[1925] AC 619. Macaura owned a timber estate in Northern Ireland which he insured in
his name. He formed a company and transferred the ownership of the estate into the
names of the company, but he did not change the insurance policy. The estate was gutted
by fire and his attempt to claim for compensation did not succeed. The House of Lords
held that the timber did not belong to Macaura but the company, and therefore Macaura
did not have an insurable interest in the timber.
4. When the company is properly formed it acquires full contractual capacity like that of
natural persons. Under section 22 (b) of the Companies Act, a company has “subject to
 this Act and to such limitations as are inherent in its corporate nature, the capacity, rights,
powers and privileges of and individual…” This means that the company can do what a
natural person can do.
5. The Company acquires identity (name) under which it can sue or be sued.
6. The Company can commit crimes but cannot be imprisoned.
7. The Company acquires perpetual succession under section 22 (a) of the Companies Act.
This means that the company is able to outlive members, but the company exists until it
is wound up.
8. Increased borrowing capacity- when a company is formed, it acquires properties that it
can use to secure debts. As such companies are able to create fixed and floating charges
and enhance their borrowing capacity. Companies can also borrow by way od debentures.
9. A company can carry on business within and outside Zambia, as far as the laws of the
second jurisdiction permit. Thus companies are not limited by borders and can exist in
many countries at the same time, something natural persons may not do.
10. The management of company is divided between directors and shareholders. This
division of powers creates a balance of power and accountability in the business of the
company.
11. Transferability of interest (shares)-ownership of the company is easily transferred by
selling of shares. This way the company rarely runs short of capital, which is the essence
of selling shares.
Disadvantages of Incorporation of a Company
1. Cost – The initial cost of incorporation includes the fee required to file your articles of
incorporation, potential attorney or accountant fees, or the cost of using an incorporation
service to assist you with completion and filing of the paperwork. There are also ongoing
fees for maintaining a corporation.
2. Double Taxation – Some corporations may be taxed twice on profits made by the
company and dividends being paid out to shareholders.
3. Loss of Personal “Ownership” – If a corporation is a stock corporation, one person
doesn’t retain complete control of the entity. The corporation is governed by a board of
directors who are elected by shareholders.
4. Strictly regulated – A company is a public investment and is strictly monitored by
different rules for the protection and maintenance of capital. They are also required to
annually report on their performance.
5. Too much Paperwork – Most corporations are required to file annual reports on the
financial status of the company. The ongoing paperwork also includes tax returns,
accounting records, meeting minutes, licenses and permits for conducting business.
6. Difficulty Dissolving – While perpetual existence is a benefit of incorporating, it can also
be a disadvantage because it can require significant time and money to complete the
necessary procedures for dissolution.
7. Lifting of Corporate Veil – If courts religiously follow strictly Salomon v. Salomon and
Co. Ltd.,1897, A.C 22, the ‘Veil of incorporation’ may not be pierced and natural people
can hide their bad deeds behind the veil. But the Companies Act provides a wide range of
 circumstances when the corporate veil can be pierced to expose natural persons, such as
directors and employees that may have abused the veil of incorporation.
Lifting the Corporate veil
When a company is formed, the separate legal personality acts as a shield protecting members
from the scrutiny of courts. This screen is referred to as the veil of incorporation. However,
courts do not religiously follow the rule established in Salomon and Salomon & Co Ltd, and may
pierce the corporate veil to make directors or employees of the company personally liable. This
can be done in two ways, lifting the corporate veil by statute (Companies Act) or by common
law (decided cases):

Lifting the Corporate veil by statute (Companies Act, 2017).

1. If an offence by the corporate body can be traced to the director, shareholder or manager
of the company, the natural person shall be charged and fined upon conviction, unless he
proves to the satisfaction of the court that the offence was done without his knowledge,
consent or connivance, and that he had taken reasonable steps to prevent commission of
the offence (section 371 of the CA).
2. When the promoter fails to comply with the requirements of registration of a company,
he commits an offence and is liable upon conviction to a fine. (s. 364 (1) of the CA)
3. Where the number of directors falls below the prescribed minimum 1, (not less than 2 for a
private company and not less than 3 for a public company 2), for more than three months,
the company and each officer commit an offence and will be fined upon conviction.
4. An individual under a Disqualification Order of the court cannot act as a director and if
he does, he is personally liable for any purported actions. Under section 93 (1) of the CA,
a director who has committed an offence or breached any of the duties of a director, may
be prevented from holding office for a period not exceeding 5 years by a Court Order. If
he is appointed director during that period, it is illegal and the corporate veil may be
lifted to expose his misdeeds and make him personally responsible for anything that may
go wrong in that period.
5. Wrongful or fraudulent trading: this is provided for under section 362 of the CA, and
states: “Without prejudice to the Penal Code, a director of a company who—(a) by false
pretenses or other fraud, induces a person to give credit to the company; or (b) with intent
to defraud a creditor of the company—(i) gives, transfers or causes a charge to be given
on property of the company to another person;(ii) causes property of the company to be
given or transferred to a person; or (iii) causes or is a party to an execution being levied
against property of the company; commits an offence and is liable, on conviction, to a
fine not exceeding two hundred thousand penalty units or to imprisonment for a period
not exceeding two years, or to both”.

The Difference Between Wrongful and Fraudulent Trading

1
Section 90 of the Companies Act 2017.
2
Section 85 (a) and (b) of the Companies Act 2017.
Fraudulent trading is when a company carries on business operations with the intent of
purposefully deceiving and defrauding its creditors. This is a criminal offence and is punishable
by steep fines/debt liabilities depending on the severity of the fraud and potentially improvement.

Wrongful trading is when a company continues to trade as normal even though the
managers/directors were aware (or should have been aware) of the fact that the company was
going out of business.

How Are Directors Accused of Wrongful or Fraudulent Trading?

Any company that enters insolvency through a winding up process (i.e- compulsory or voluntary
liquidation) will be subject to a thorough investigation conducted by the liquidator. The goal of
the investigation is to ascertain whether the directors of the company were guilty of wrongful or
fraudulent trading while the company was insolvent. If the liquidator believes the directors did
not fulfil their duties while trading insolvent they may present this accusation to the court in the
investigation summary.
How to Avoid Wrongful or Fraudulent Trading Accusations
The best way to prevent the possibility of being accused of wrongful trading is to consult with an
insolvency practitioner as soon as you feel your company is no longer able to keep up with its
financial obligations. Aside from seeking professional assistance expeditiously, here are some
tips to help you minimise the risk of being accused of wrongful or fraudulent trading once you've
realised your company is trading insolvent:
6. Keep thorough documentation of all income and expenditure
7.
8. Contact an IP once you're aware that the company is unable to repay its debts
9.
10. Do not lie to creditors or attempt to deceive them in any way
11.
12. Act in the best interest of all creditors as a whole; do not show preference to any
individual party that you owe.
13.
14. Do not attempt to sell your assets (i.e. - inventory, equipment, property etc.) at a price
that is lower than the market value – this could be construed as a transaction at under
value. If you are considering liquidation as a solution look into a formal voluntary
liquidation instead.
15. If you’re concerned that you could be accused of wrongful or fraudulent trading in the
near future, call us today on 0808 253 5299, or send us an email to participate in a free
consultation. We’ll help you assess your current risk level and devise a plan of action to
keep your company’s directors protected from liabilities and legal repercussions.
16. Real Business Rescue provide director advice online, over the phone, or in-person at one
of our 85 UK offices or a place of your convenience.
17.
18. Falsification of records: Without prejudice to the Penal Code, a director, officer,
employee, or shareholder of a company who, with intent to defraud or deceive a person—
 (a) destroys, displaces, mutilates, alters, falsifies or is a party to the destruction,
mutilation, alteration or falsification of any register, accounting records, book, paper or
other document belonging or relating to the company; or Furnishing false document,
(b)makes, or is a party to the making of a false entry in a register, accounting record,
book, paper, or other document belonging or relating to the company; commits an
offence and is liable, on conviction, to a fine not exceeding five hundred thousand
penalty units or to imprisonment not exceeding five years or to both3.
19. Furnishing false or misleading documents: if a director or employee of a company who
knowingly makes, submits or authorises the making or submission of a false or
misleading statement or report with regard to—
(a) a director, officer, employee, inspector, shareholder, debenture holder or assignee
for debenture holders of the company;
(b) where the company is a subsidiary, a director, officer, employee or inspector of its
holding company;
(c) a stock exchange or an officer of a securities exchange; or
(d) the property of the company; commits an offence and is liable, on conviction, to a
fine not exceeding two hundred thousand penalty units or to imprisonment for a
period not exceeding two years, or to both.
8. Liability where a Company name is incorrectly stated: Where the name of a company is
incorrectly stated in a document which evidences a legal obligation of the company, and
the document is issued or signed by or on behalf of the company, every person who
issues or signs the document is liable to the same extent as the company unless the
(a) person who issues or signs the document proves that the person in whose favour the
obligation was incurred was aware at the time the document was issued or signed, that the
name was incorrectly stated and the obligation was incurred by the company; or Registrar
may direct change of name Document with incorrect name not void Liability where
company name incorrectly stated
(b) Court before which the document is produced, is satisfied that it would not be just and
equitable for the person who issued or signed the document to be held liable.4

Lifting the corporate veil under common law

Courts are prepared to lift the corporate veil:
(a) When someone acting on behalf of the company signs or authorises the signing of a
document in which the company name is incorrectly stated.
(b) If the company was formed to evade a legal obligation: in Gilford Motors v Horne,
1933] Ch 935, Gilford Motors employed Horne as a salesperson. His contract
stipulated that he would not compete with his employers upon expiry of his contract.
To avoid this obligation when he resigned, he set up his own business, JM Horne &
Co. Ltd, in which his wife and friend, Howard, were the shareholders and directors.
He run the business parallel to Gilford Motors. The Court were prepared to lift the
corporate veil, and once it was established that Horne was behind the company, the
3
Section 361 of the CA
4
section 45 of the CA
 court issued an injunction restraining JM Horne & Co. Ltd from competing with
Gilford Motors, as it was a “sham or fraud”.
(c) If it is just and equitable to do so: in Re a Company, 1990, BCC 526, the company
exceeded its overdraft limit and had fallen behind in PAYE payments, national
insurance contributions, VAT and debts to creditors amounting to £212,618. But Mr.
Barford, the company director and majority shareholder increased his salary. It was
held that this was a real moral blame. How could Barford increase his salary when the
company was heavily in debt? He was found guilty of wrongful trading and
personally liable for the debts of the company, amounting to £156, 420. It was
therefore just and equitable (fair) to lift the corporate veil and expose the greed of Mr.
Barford.
(d) Enemy character - a company assumes an enemy character if the persons in the
control of its affairs are residents of an enemy country. The courts will lift the
corporate veil and examine the character of persons in control of the company to
establish whether the company has assumed enemy character. In Daimler Co. Ltd v.
Continental Tyre & Rubber Co. Ltd, 1916, AC 307, Continental Tyre and Rubber Co
Ltd was incorporated in England, and supplied tyres to Daimler Co. Ltd. All except
one of its shares were held by German residents and all directors were German
residents. The secretary was English. After war broke out with Germany, the tyre
company sued Daimler for the cost of goods supplied before the war started. Daimler
argued that since members and officers of Daimler were Germans, paying the debt
would amount to trading with the enemy, in breach of section 3 (1) of Trading with
the Enemy Act 1914. Daimler stated that the matter should not go for trial, and the
court agreed. Notwithstanding that the domicile and nationality of a company is
determined by its place of registration and place of the registered office, the court was
prepared to lift the corporate veil to determine the individuals behind the company,
and if they were enemy aliens, the company should also be regarded as such.