The concept of a separate legal entity allows companies to make contracts by using their own names and seal. Under this principle, companies live and conduct their activities to their own competence. The company is in a position to carry on its business, generate revenues, hire employees, and pay its taxes. It is a better form of existence for companies because it takes its own responsibilities. The company can go for the best talent in the market. There will be a clash of interests as shareholders and creditors are not involved directly in the running of the business. The business has a better scope for multiple business activities such as retaining a professional setup, securing debts, and expanding business. The business will realize its objectives with ease (School 2014).
The concept of a separate legal entity reduces the need for monitoring control of the company. In most cases, when shareholders are involved directly with the running of the company business they brew mistrust to each other. When one person comes up with an idea that may increase the chances of success of the business, other shareholders may tend to question the motive. Some of the shareholders believe that the motivation may be for personal gain. Such wrangles may derail the growth of a company. Separate legal status does not give room to such wrangles, as shareholders are not involved with the affairs of the company directly (School 2014).
The concept of a separate legal entity is an innovative one. It reduces the uncertainty of concern for the business amongst shareholders and creditors. Investors are purely dependable to the shares that they subscribe to and thus the risk of investment is reduced a great deal because of the separate status of the company. In an event of insolvency of the company, shareholders or owners of the company are not required to contribute their personal assets during the liquidation process. In some cases, when a company is dissolved it may not be in a position to pay its debts and shareholders must chip in with their assets to settle the matter. Under the principle of a legally separate entity, the company acts in its own and shareholders cannot be involved directly in the affairs of the company either financially or management. Shareholders can venture into risky businesses without worrying about the outcome, as their personal assets are not tied to those of the business (Mangal 2001).
A separate legal entity separates a business from its owners. As a person formed by law, the entity of the association is highlighted. The principle allows companies to live as much as necessary in order to conduct their business activities without any doubts regarding the biological death of their owners. With this in mind, companies can foresee the goals set by the generation of members. Each generation will work for the set goals and after achieving them, they set other goals that can sustain the business. In an event that company business is sold, every contract of the former business is good since the business remains the same. The separate personality of the company gives rise to essential effects. The company has the capacity to own its property, have its own rights, and be subjected to its own compulsions. These obligations, rights, and property vary from those of members. Members do not necessarily enjoy what the company is enjoying (Latimer & CCH Australia Limited 2011).
In addition, what is borne by the company is not necessarily borne by the company owners. Any action that is instituted by the company against third parties for payment of debts made to the former by the latter may not hold. In essence, the assets and liabilities of the company are distinct from those of members. Just like a natural person, once the company is registered and incorporated, it will have its right to sue in its own name (Latimer & CCH Australia Limited 2011).
The principle of a separate legal entity disconnects management from investment and this enables the investing members of the public to share profits without being part of the management. Professional management can be hired to run the business. Professional managers are critical to the success and sustainability of the company because they bring collective wisdom. This promotes the swift advancement of the company because the management is bound by professional decision-making and not in the case where personal interests guide owners. Professional management maintains the continuity of the firm when there is a change of board of directors of the company. This makes sure the daily activities of the firm are not interfered (Casenotes 2004).
The separation of management from investment increases the value and salability of a company. The mixture of management and investment is stressful and time-consuming. Employing specialists to run the company on behalf of the owners as asserted by the principle of separate legal entities increases the property value of the company. Separate legal status reduces transaction costs. There are well-underlined normal rights that shareholders are expected to follow. No time is wasted trying to explain concepts of issuing of shares whereby in most cases, the board of directors needs to sit down and chat the way forward.
Essentially, the principle of a separate legal entity acts as a vehicle for businesses to accumulate an enormous amount of outside capital for the business. Furthermore, it offers considerable confidence and convenience to the investors. This will encourage investments thus boosting economic growth in the society.
The principle of a separate legal entity is a perfect medium for fraud. Shareholders may set up an undercapitalized and water-thin company. Once they are through with this stage, they can cause the corporation to incur huge debts under its own name because it is a separate entity. This company may not be able to meet the debts. When creditors ask for repayment, the owners of the company may assert that the company suffered bad debts and they are not liable because the company acts as a separate legal entity (Tomasic, Bottomley, & McQueen 2002).
In addition, the concept of a separate legal entity is subject to corporate fraud. Assets of the new corporation may be transferred to another corporation in order to escape tax liability. This kind of transfer is always carried out in a series of transactions that are so confusing in order to conceal the real design of the scheme. When the funds are traced back, the investigators may fail to establish a direct link to the new corporation. The new asset-rich company will attempt to dispel the assets by granting unsecured and interest-free loans. Under this principle, the directors for management are likely to be paid astronomical fees (Silverstone & Sheetz 2011).
The concept is weak in protecting interests from outside creditors. Honest incorporators may be given benefits in unclear circumstances in order to cheer others to come and invest in the company. The principle asserts that management should be separated from shareholders. Shareholders are therefore discouraged from monitoring the commercial ventures of the company. Furthermore, subsidiaries can easily be abused in order to keep away from debts by transferring assets between the parent company and its subsidiaries. Essentially, creditors are prevented from claiming their rights directly to shareholders. The implication is that creditors (both tort and contracting) will bear more risk when handling companies under separate legal entities. The principle functions best by offering the shareholders the platform to fraud creditors because they are protected by the law (Meiners, Ringleb, & Edwards 2012).
The principle of a separate legal entity underlies the responsibility of the state to take control of the process of incorporation in a country. It also denies the state the responsibility to inspect corporations. This is because, under the principle, corporations are separate entities that cannot be subjected to any form of scrutiny. It bridges state rules because it will create unequal control of corporations in a nation. Corporations that are directly controlled by the state may feel forces of discrimination thus ensuing battles. Corporations under this principle may use many resources to defend themselves. This may lead to losses. The principle increases the cost of separation of management and control. The process of constituting management that can take care of the organization is tedious. The principle of a separate legal entity has some strict rules to follow. This leads to increased regulations. More time is wasted while working to live by the rules (Giles 2012).
Casenotes. 2004. Business organizations. New York, Aspen Publishers.
Giles, S. 2012. Managing fraud risk: A practical guide for directors and managers. Hoboken, Wiley.
Latimer, P. S., & CCH Australia Limited. 2011. Australian business law 2012. North Ryde, CCH Australia.
Mangal, R. 2001. An introduction to campany law in the Commonwealth Caribbean. UWI.
Meiners, R. E., Ringleb, A. H., & Edwards, F. L. 2012. The legal environment of business. Mason, South-Western Cengage Learning.
School, T. C. L. 2014. Company law in practice. S.l., Oxford University Press.
Silverstone, H., & Sheetz, M. 2011. Forensic Accounting and Fraud Investigation for Non-Experts. London, John Wiley & Sons.
Tomasic, R., Bottomley, S., & McQueen, R. 2002. Corporations law in Australia. Sydney, Federation Press.