The Fallacy of Complete Corporate Separateness

In a paper recently made available on SSRN, I identify and debunk a recurrent logical fallacy relating to the analytical and normative consequences of the well–established fact that corporations have a separate legal personality. In informal logic, a fallacy of equivocation occurs when a term is used with one meaning in the premise and with another meaning in the conclusion. We observe just such a fallacy in corporate law discourse about corporate separateness: the term ‘separate’ is used with two different meanings. 

The adjective ‘separate’ has many different meanings, but two of them are most relevant for our purposes: 

• ‘Separate’ as distinct with independent existence; and 
• ‘Separate’ as insulated or impermeable.

These two meanings should not be confused or conflated. One thing is to say that, as a legal person, a corporation constitutes a separate distinct nexus for the imputation of legal rights and duties, which is indeed the very definition of legal personality. Another is to argue that, by logical imperative, the legal sphere of the corporation must be completely detached from that of shareholders in all respects, a conclusion that does not capture the actual operation of the law, nor is it normatively desirable, in a wide array of circumstances. 

While the first premise is well-known and uncontroversial, scholars and practitioners commit the fallacy of equivocation in discussing the legal consequences of corporate separateness with surprising frequency. Because the corporation is a separate legal person under the law, the argument goes, shareholders must enjoy limited liability for corporate obligations, the jurisdictional connections of a subsidiary must not be imputed to its corporate parent, and corporations must not enjoy constitutional protection as a vessel for the exercise of shareholder constitutional rights. Although prevalent in the writings of prominent scholars and in numerous judicial disputes, this type of argument is a fallacy of non sequitur and does not describe the actual functioning of the law in numerous contexts.   

Corporations are actually treated as legally connected to—and not insulated from—shareholders, especially controlling shareholders, across a wide variety of legal rules and areas of law, including corporate law. The creation of a separate nexus for the imputation of rights and duties does not and should not beget complete legal insulation from other persons. My paper unpacks the different meanings and functional dimensions of corporate separateness, distinguishing between the creation of a new nexus for the imputation of rights and duties (legal capacity), the separation between the entity’s assets and those of its members (asset partitioning), and the separation of the legal sphere of the entity and that of its members for purposes of the imputation of legal consequences (which I term regulatory partitioning).

The legal connectedness between legal persons and related parties should not be surprising given the legal treatment of natural persons. Although different human beings are also recognized as separate persons under the law, their legal spheres are also bonded in various ways. Many jurisdictions impose vicarious liability on parents for torts committed by their children, as well as on employers for wrongful acts of employees during the scope of employment; spouses, close family and business partners are often not deemed independent from one another in the assessment of potential conflicts of interest. Examples of interconnectedness abound.

Justice Oliver Wendell Holmes once argued that a leading purpose behind the corporations’ real usage ‘is to interpose a nonconductor through which, in matters of contract, it is impossible to see the men behind them’ (see, Donnell v. Herring-Hall-Marvin Safe Co., 208 U.S. 267, 273 (1908)). While such insulation through regulatory partitioning is indeed a key driving force behind the creation of corporations, it does not apply equally in all contexts. Another decision by Justice Holmes himself years later discounts the relevance of this legal separation in order to implement the policy of a statute (see, Flink v. Paladini, 279 U.S. 59, [62–63] (1929)). 

A more apt metaphor is in order to describe the effects of corporate personhood. Rather than a nonconductor that completely insulates the company from the legal spheres of related parties, legal personality operates as a semi-permeable membrane that is more or less pervious to rights and duties of shareholders depending on the legal issue in question. The level of permeability in any given case is rather a matter of public policy; the analysis necessary in order to make such decisions should not be clouded by logical fallacies like the one described in my paper.

Mariana Pargendler is Professor of Law at Fundação Getulio Vargas School of Law in São Paulo and a Research Member of the European Corporate Governance Institute (ECGI).