AN ANALYSIS OF CORPORATE GOVERNANCE IN ISLAMIC AND WESTERN PERSPECTIVES
Part-II: Corporate Entity and
Limited Liability
By
MALIK M. HAFEEZ,
LL.B., LL.M. and
MUHAMMAD ABBAS AZEEM[1]
1.
Introduction
A
company is a species of corporation and has a dual nature as both an
association of its members and legal or artificial person quite distinct from
its members. A company being a legal and separate person can own property for its
organisational benefits and interests rather than as
agent or trustee of its members.[2] A company being a distinct and separate legal entity from its
members have rights and duties. The company can sue against any person
to enforce its rights and be sued for any breach like any other person.[3] The
company business is conducted by the company as a separate person rather than
for its members. Company being a person enters into contract with other parties
even with its members in relation to company business and property. The
labiality of the company as a legal person might be unlimited but the liability
of its members might be to the extent of their share or contributions. However,
the natural persons being the agent of company and trustee of its assets run the
affairs of company but they are accountable to the members of the company. The
case, Salomon v A Salomon & Co Ltd,
clearly established the principle of distinct legal personality of the company
in British jurisdiction. In Islamic perspective, the concept of legal
personality is clear in the light of these three institutions, Bait-ul-Mal,
Waqaf and Masjid, which
were developed in Khilafah (Islamic State) through
the ages.
2.
Corporate Entity
and Limited Liability in Islam
The concept
of a company does not appear to be against the Injunctions of Islam. The
formation and incorporation of a company under any legislative procedure of the
state has a legal status of artificial person having legal entity rather a
natural person with some rights and obligations. For instance, a company can
acquire any property in any capacity (i.e. as an Owner, Lessee, Pawnee and
Mortgagee etc.), alienate its property, sue and be sued on its own name, manage
its property or affairs according to its constitution, incur financial liabilities
and acquire financial rights. In Islam system of state these examples relating
to incorporation and formation of legal persons i.e. Baitul
Mal, Waqf and Masjid can be
found which have all of the afore-mentioned characteristics of legal person.
The concept
of Company limited by shares prevailed in modern corporate scenario is not
repugnant to the Injunctions of Islam because the status of an institution as a
legal person is not prohibited by (Sharia) Islam
system. A company limited by share is incorporated by group of natural or
artificial persons. They subscribe different number of shares with equal
denomination and therefore their liability is limited to the extent of their
shares’ subscription. However, a company as a legal personality has unlimited
liabilities to its creditors which is not against the Sharia or Islamic injunctions, as laid down in the Holy Quran and Sunnah of the Holy Prophet. The principles of Islamic law
of contract and partnership provide comprehensive framework of commercial practices
and concept of liability which were adopted by the early jurists. The terms of
contractual arrangements are binding on the contracting parties because it is
considered that these are not repugnant to any injunctions of the Holy Quran
and Sunnah. For instance, the Islamic principle of
"Istehsan" and "Umoomul
Balwa" are modes to come out from difficulties
and hardship. Similarly, the principle of "Muslahah"
is exercised through taking step, action, policy- matter for the best interest
of the people. Anything leading to or seeming to lead to some difficulty,
hardship or injury to the persons generally or to any offence, immorality or
injustice shall be prohibited under the principle of "Saddul
dhriah" and "Fathuldhriah".
The repugnancy of any act or omission and its merits and demerits is examined
on the principle of "Ibahah".
However,
it is well settled principle of law and
Islamic Jurisprudence that an action, deed or thing which is not specifically
prohibited by Injunctions of Islam (Quran and Sunnah)
is considered to be permitted/allowed in Islamic system. An incorporation of
company or company limited by shares being an artificial and legal person do
some business that is not prohibited by Islam and nothing exists in Quranic injunctions or Sunnah should
not be considered un-Islamic and against the Sharia
because the company is a modern form of partnership business which is permitted
by Islamic law. The partnership is a contract in which a few individuals join
together for the purpose of doing business, with property, skills and goodwill.
The three kinds of partnership as "Shirkat al Amwal", "Shirkat al
Mal" and "Shirkat al Wujuh"
respectively have similarity with modern form of corporate activities.[4]
Therefore, it might be argued that the incorporation of company as a legal
person with limited liability of its members is not against the injunctions of
Islam. The registration of an association, partnership and incorporation of
company as a legal person and juristic person is allowed in Islam as in the case
of State treasury, Waqf, hospital, etc.[5] It
is admitted that Mudaraba company (Profit-sharing)
was an antiquarian institution of pre-Islamic times which was suitable for
distant trade journeys and even this mode of corporate business is considered
an ideal form of corporation in Islamic world.
On the other hand, it is argued that the Islamic Fiqh Academy of OIC in its seventh Session held in the
month of May, 1992 adopted Resolution No.7/1/65, in relation to corporate
issues in following manners:[6]
Shares In Sharikat(a) As the
original rule in Mua'milat is permissibility, The
formation of Sharikat Musahimah
having lawful objectives and activities, is lawful. (b) There is no disagreement about the prohibition of the shares of Sharikat whose primary objective is prohibited, like
transactions in Riba or which produces and deals in
prohibited products. (c) The rule of
prohibition applies to the shares of Shrikat that
deal at times in prohibited things like riba, even
when their primary activity is permissible.
Shares with Respect to their Bearer:
The share certificate is the instrument that is proof of his right in the
share. There is, therefore, no legal obstacle to the
issuance of shares in this way and to transactions in them.
Subject- Matter of the Contract in the Sale of the
Share: The subject-matter of the contract in sale of shares is the undivided
share in assets of the Sharika. The share certificate
is the instrument of the right to this share.
The Joint Stock Company business is regarded as
akin to the contract of Shrikah in Islamic legal
system by the Islamic jurists.[7]
They considered that the incorporation of company having the status of distinct
legal personality is permissible in Sharia (Islamic
law). They argued that:
“the
Limited Liability of the master of a slave who carries on business on behalf of
his master was also cited. In such a case the initial capital for the purpose
of trade was provided by his master, but the slave was free to enter into all
the commercial transactions. The income would also vest in him, and whatever
the slave earned would go to the master as his exclusive property. If in the
course of trade, the slave incurred debts, the same would be set off against
cash and the stock in the hands of the slave. But if the amount of such cash
and stock would not be sufficient to set off the debts, the creditors had a
right to sell the slave and settle their claims out of his bid price. However,
if their claims still remained due even after selling the slave, or the slave
would die in that state of indebtedness, the creditors shall not approach his
master for the rest of their claims. Here, the master was actually the owner of
the whole business, the slave being merely an intermediary tool to carry out
the business transactions. The slave owned nothing from the business. Still,
the liability of the master was limited to the capital he invested including
the value of the slave. After the death of the slave, the creditors could not
have a claim over the personal assets of the master. This business practice was
followed in the days of Holy Prophet (P.B.U.H).”[8]
The concept of
corporate entity and limited liability of the company’s member is not against
the injunctions of Islam. As Abdul Rahim observed
that "it may be doubted whether the earlier jurists would recognize an
artificial or Juristic person. The state of community is regarded by them as
holding and exercising the rights of God on His behalf through the Imam.
Similarly the deceased is spoken of as having rights and obligations on his
estate, for the law deals both with a man's spiritual and worldly rights and
obligations and even the worldly rights and obligation of a person cannot be
said to be altogether lost on his death, in as much as he is entitled to have
his funeral expenses and his debt and other obligation discharged out of his
estate. But later jurists seem inclined to recognize an artificial person, for
instance, they would allow a gift to be made directly to a Mosque, while the
ancient doctors would require intervention of a trustee."[9]
However, It is also
recognised that "the Islamic law has since its
dawn, recognized the existence of juristic persons. The jurists have discussed
the state treasury (Bait-ul-Mal) and Waqf as juristic persons. Similarly, they have considered
the schools, orphanages, hospitals, etc., as juristic persons and competent to
hold and exercise the rights."[10] Further argued
that:
"When
we referred to the original text and sources of the Shariah,
we found in its legal provisions which in substance propound the concept of
Juristic person and its legal status. And, also, we found the legal provisions
which personify the juristic person with all its 'principles and
characteristics which are attributed to it by the latest western law . . . on
the same pattern of the latest western legal position of the juristic person,
it is found in the Shariah in the most perfect form
in the shape of the Treasury, Waqf and the estate in
which the head of the State personifies the entire Muslim Community."[11]
On the other hand, the Muslim jurists have
consensus about the Waqf being a legal and religious
institution for charitable purpose wherein properties are dedicated to the waqf that deprived the donor from ownership of the donated
property.[12]
The beneficiaries of Waqf can only enjoy the benefit
and proceeds from the corpus or dedicated property rather than becoming its
owners because the ownership of Waqf property vests
in Allah Almighty alone. The Waqf is regarded as a
separate legal entity and have ascribed to it some characteristics similar to
those of a natural person.[13]
The mosque is also regarded equal to the waqf because
it also has capability to own properties.[14] Shaikh `Ali Khafif recognised the existence
and assignment of legal person in the ambit of prevailing rules of Shariah and its
functions in public interest that is not prohibited by the injunctions of
Islam.[15]
The concept of legal personality is accepted
the concept of limited liability should flow naturally from it.[16]
The court also holds the attribute of legal person to a Mosque; however this
decision was set aside by the superior court.[17]
The Federal Sheriat Court also upholds the legal
entity of the company with limited liability of its members in Islamic law
relying on above-mentioned arguments.[18]
3.
Corporate Personality
and Limited Liability of its Members in British System
The fundamental attribute of corporate personality
is that the company is a legal entity separate from its members who constitute
it. Being a legal person, company is capable of enjoying rights and subject to
duties which are different from its members. In other words, company has ‘legal
personality’ and is described as an artificial person in contrast with a
natural person.[19] Company as a distinct legal entity can
own property, enter into contract, and be a party to legal proceedings. This
separate entitlement of a corporate personality does not allow its members to
own the company’s property, carry on its business and owe its debt.[20]However,
the company as a corporate personality recognised and
became an attribute of the normal joint stock company at the end of 19th
century that was a last stage of its development. The House of Lords in case, Salomon v A Salomon & Co Ltd,[21]
clearly established the independent legal personality of a limited liability
company by making every efforts on behalf of creditors of a failed company and
to declare that the liability for the company’s debts cannot be imposed on its
controlling shareholders because of separate legal entity of the company from
its members who have limited liability to the extent of their unpaid
subscription of share-ownership.
This
leading case not only established the principle of ‘legal personality’ but also
laid down the concept of ‘limited-liability’ of company’s shareholders to the extent
of their unpaid subscription of share-ownership. Later on both
principles, corporate personality and limited liability, which are outcome of
the decisions of British courts, were incorporated in legislation not only in
Common-Wealth jurisdiction but rest of the world as a whole to remove the
ambiguity of corporate market. The brief facts of case are that:[22] Salomon had a
prosperous business as a leather-merchant ran it in his personal ownership as a
sole proprietor. In 1892, he converted his sole proprietorship into a limited
company i.e. Salomon & Co Ltd in which Salomon, his wife, and five of his
children were the members and shareholders of the company and Salomon himself
was appointed as a managing director of the company. The company (i.e. Salomon
& Co Ltd) purchased the business from Salomon as a going concern for
approximately £39000. The price was satisfied to Salomon as seller of his
business by issuing secured debentures in the amount of £10000, which conferred
a charge over all company’s assets, 20,000 shares in fully paid £1 share were
issued to him other than seven shares that were issued to all subscribers of
the memorandum and rest of the approximately amount £9000 were paid to him in
cash in satisfaction of the balance of the purchase price. The company almost
immediately got business slump and went into liquidation for which debenture
holders appointed a receiver. However, the company assets were sufficient to
discharge the secured debenture but nothing was left for unsecured creditors. The
company’s liquidator in representation of unsecured creditors claimed that the
company’s business was in reality still Salmon’s, the company being merely a
sham design to limit Salomon’s liability for debts incurred in carrying on its
business, and therefore Salmon should be ordered to indemnify the company
against its debts, and payment of his secured debentures debt should be
postponed until the company’s other creditors were satisfied.
The trial court did
agree with liquidator’s claim and observed that the subscribers of the
memorandum other than Salmon held their shares only as nominees of Salomon, and
Salomon sole purpose to form a company is to use it as an agent of running his
business.[23] The Appellate
Court reached to the same conclusion of the trial court and observed that the
companies Acts were intended to confer the privilege of limited liability on
genuine, independent shareholders who invest their capital in company to enable
it for starting its business rather than sole owner of the business who involve
his family members as nominees to satisfy the formalities of incorporation of
company to carry own his business under the protection of limited liability.[24]
The House of Lords
unanimously reversed the decisions of trial and appellate courts and held that
the Salomon is not liable to pay company’s debts to its creditors and his
debentures are secured that are validly issued and therefore, he should be
given priority in payment of debentures being a secured debenture holders from
company assets over non-secured creditors. The court held that:
“Either the limited company was a
legal entity or it was not. If it was, the business belonged to it and not to
Mr. Salomon. If it was not, there was no person and nothing to be an agent at
all; and it is impossible to say at the same time that there is a company and
there is not . . . The company attains maturity
on its birth. There is no period of minority - no interval of incapacity. I
cannot understand how a body corporate thus made “capable” by statute can lose
its individuality by issuing the bulk of its capital to one person, whether he
be a subscriber to the memorandum or not. The company is at law a different
person altogether from the subscribers to the memorandum; and, though it may be
that after incorporation the business is precisely the same as it was before,
and the same persons are managers, and the same hands receive the profits, the
company is not in law the agent of the subscribers or trustee for them. Nor are
the subscribers as members liable, in any shape or form, except to the extent
and in the manner provided by the Act.”[25]
This principle of
corporate legal personality and limited liability of its shareholders has been
fully applied by the courts since decisions of the Salomon case. The decision
of Salomon case recognised that a company business is
conducted by company itself as a separate person from its members.[26] The defamatory
statement about company’ business that defames the company enables it to sue as
separate legal person for libel and slander.[27] The court
explained that a company’s property is the property of company as separate
person from its members rather than its shareholders.[28] The company itself
is normally both the legal and beneficial owner of its property.[29] Company as a legal
person not only own its property but enter into contracts for any transaction
with its members also.[30] The company as an
artificial person cannot die with the death of its members but it survives
until winding up and completion of liquidation.[31] Therefore, the
company is a legal person has got a statutory status in British system and rest
of the world also.[32] However, the
courts occasionally did not apply the principle of separate legal personality
by lifting the corporate veil to define the proper ends of incorporation.[33] The courts
normally lift the corporate veil in circumstances of paramount public interest;[34] evasion of
obligation imposed by law;[35] implied agency and
trusteeship;[36] fraudulent trading
activities;[37] under companies
law and related legislation.[38]
4.
Conclusion
The word ‘person’
is normally used to individual human beings but in law it has technical meaning
to subject of ‘rights and duties’. The law give the
status of legal person to the inanimate entities, such as funds and companies.
Although the legal person might be artificial juristic person but it can own
property, run its business might be a party in any legal proceeding separately
from its members like natural person. The three examples (i.e. Baitul Mal, Waqf and Masjid) of Islamic Legal system (Khilafa)
provide an innovative concept of legal entities and institutions having the
concept of legal personality and limited liability to the Muslims and the rest
of the corporate community. However, the Western world took the concept of
corporate personality and limited liability of its shareholders in the end of
19th centaury but these examples (Baitul
Mal, Waqf and Masjid) of
Islamic legal system convinced that the Islamic states are adopted the
principle of legal person and limited liability since ages. I have no
hesitation to conclude that both the Islamic and western legal systems have
consensus about the applicability of company as juristic person and limited
liability of its members and both of them has not any conflicts on the
prevailed principle of corporate entity. This is the reason,
these principles are in practice in both the Islamic and Western jurisdictions.
---------------------------
THE END
[1]. Malik M. Hafeez is a principal
Author and Muhammad Abbas Azeem
is a Research Associate of Principal Author
[2]. Macaura v
Northern Assurance Co Ltd, [1925]
AC 534 at pp. 545
[3]. Daimler Co Ltd v Continental Tyre and Rubber Co (Great Britain) Ltd, [1916] 2 AC 307
at pp. 338
[4]. Ibn Nujaim "Al-Bahr
Al-Raiq" Vol. 5, (Beirut: Dar
al-Ma’rifah1993) at pp. 170
[5]. Abdal Qadir Audah, "Al Tashria al Janai". Vol. 1, at pp. 292
[6]. Federal
Government v Provincial Governments, P L D 2009 Federal Shariat Court 1
[7]. Federal
Government v Provincial Governments, P L D 2009 Federal Shariat Court 1
[8]. Federal Government v Provincial
Governments, P L D 2009
Federal Shariat Court 1
[9]. J. A. Rahim, "Principles of Islamic Jurisprudence and to
Josef Schacht”, in, An Introduction to Islamic law, (Oxford 1964) at pp. 125: Federal
Government v Provincial Governments, (n. 8)
[10]. Abdul Qadir Awdah, Al-Tashri `ul Jenai al Islami, Mussasat al Risalah, (Beirut: Muassasah al-Risalah 1992) Vol.1, at pp. 393; Federal
Government v Provincial Governments, (n. 8)
[11]. Mustafa
Zarqa, Al-Madkhal al Faqhi-al-Aam, Vol.3 (2 j. Damsyiq:
t.p. 1968) at pp. 253 & 258; Federal Government v Provincial
Governments, (n.
8)
[12]. Muhammad
Bin Abi al Abbas al Ramali, Nihayatul Muhtaj Ila Sharh
Al-Minhaj, (Beirut), Vol.5 at pp. 385
[13]. Abu Bakar Muhammad bin Abi Sehal Sarkhsi, Al Mabsut Lil Sarkhsi, Beirut, 1406 A. H, Vol.12, at pp. 34
[14]. Muhammad
Bin Abi al Abbas al Ramali, Nihayatul Muhtaj ila
Sharh al Minhaj,
Beirut, Vol.2. at pp. 112; Ahmad Al-Dardir, Al Shrhul Kabir, Vol:4 at pp. 77
[15]. Shaikh `Ali Al-Khafif, Al-Sharikat Fiqhal Islami at pp. 25
[16]. Justice
Mohammad Taqi Usmani,
"The Principle of Limited Liability From the Shariah
Viewpoint," New Horizon, Aug/Sept 1992, at pp. 21-22
[17]. Federal Government v Provincial
Governments, (n.
8); Masjid Shahid
Ganj and others v. Shermani
Gurdwara Parbandhak
Committee Amritsar and others,
AIR 1940 Privy Council 116.
[18]. Federal Government v Provincial
Governments, P L D 2009
Federal Shariat Court 1
[19]. Paul
L. Davies, Gower and Davies’ Principles
of Modern Company Law, (Sweet & Maxwell 2003) 27
[20]. Derek
French, Stephen Mayson, & Christopher Ryan, Mayson, French & Ryan on Company Law, 26th
ed. (Oxford 2009-10) 122
[21]. Salomon v A Salomon & Co Ltd, [1897] A.C. 22, HL
[22]. LS
Sealy, Cases and Materials in Company
Law, 7th ed. (LexisNexis Butterworths 2004) at
42-46
[23]. Salomon v A Salomon & Co Ltd, [1895] 2 Ch 323
[24]. Salomon v A Salomon & Co Ltd, [1895] 2 Ch 323 at pp. 341
[25]. Salomon v A Salomon & Co Ltd, [1897] A.C. 22, HL at pp. 31 and 51
[26]. Gas Lighting Improvements Co Ltd v
Commissioner of Inland Revenue, [1923] AC 723 HL
[27]. Jameel v Wall
Street journal Europe SPRL, [2006]
UKHL 44
[28]. Macaura v
Northern Assurance Co Ltd, [1925] AC 619
[29]. J J Harrison
(Properties) Ltd v Harrison, [2001] EWCA Civ. 1467
[30]. Farrar v Farrar Ltd, (1888) 40 ChD
395; Lee v Lee’s Air Framing Ltd,
[1961] AC 12
[31]. Re Noel Tedman
Holdings Pty Ltd, [1967]
QdR 561
[32]. The
Companies Act 2006 (UK), s. 15 (1) and 16 (2&3)
[33]. Robert
R Pennington LLD, Pennington’s Company
Law, 7th ed. (Butterwords 1995) 46-64
[34]. Daimler Co Ltd v Continental Tyre and Rubber Co (Great Britain) Ltd, [1916] 2 AC 307
[35]. Wallersteiner v Moir, [1974]
3 All ER 217; Jones v Lipman,
[1962] 1 All ER 442; Gilford Motor Co
Ltd v Horne, [1933] Ch. 935
[36]. Smith, Stone & Knight Ltd v Birmingham
Corpn, [1939] 4 All ER 116; DHN
Food Distributors Ltd v London Borough of Tower Hamlets, [1976] 3 All ER
462
[37]. Re Patrick and Lyon Ltd, [1933] All ER Rep. 590; Re Gerald Cooper Chemical Ltd, [1978]
Ch. 262; Re William C Leitch
Bros Ltd, [1932] 2 Ch. 71
[38]. Re Building and Welby’s
Contact,
[1985] Ch 663