The fundamentals of legal entity identity data – Part 1
Every contract you’ve ever signed depends on a concept most people have never thought about.
This is the first in a series of posts from OpenCorporates exploring legal entity identification – what it is, why it matters, and why the world still lacks a universal solution. This series accompanies the launch of the plei, a new approach to universal legal entity identification. We begin with a deceptively simple question.
Think about the last time you signed a contract. If it was done in a work context, perhaps it was a supplier agreement, a SaaS subscription like Salesforce, or with a new customer. You probably focused on the terms, the obligations, the price. But behind all of those details sits a more fundamental question: who, exactly, is entering into this agreement?
Not you personally. And not your organisation in some vague, general sense. And also not the counterparty you think of as the company (“Salesforce” is a brand, enforced by trademarks and IP law, not something capable of entering into a contract). The answer is a legal entity – a construct so foundational to modern commerce that we rarely stop to examine what it actually is.
The three forms of legal personality
For a contract to be enforceable, each party must possess what lawyers call “legal personality”: the capacity to hold rights, bear obligations, and be subject to legal process. Without legal personality, an agreement is just words on paper.
Traditionally, legal personality takes three forms (we will come back to this subject, as today this is a simplification that no longer represents legal reality, but remains a good starting point):
The natural person. You and I, as individuals, possess legal personality by virtue of being human. We can own property, enter contracts, and sue or be sued. This is the most intuitive form of legal personality – it simply attaches to being alive, and is the most basic and ancient form.
A group of persons acting in a defined capacity. Partnerships and certain trusts fall into this category. These were traditionally ad hoc structures, governed under Common Law, which is prevalent in Anglo-Saxon legal systems. A partnership in English Law, for example, can be done with a handshake, as two people agree to work with each other, and they are jointly and severally liable for the debts of the partnership (meaning they are personally on the hook for any debts of the partnership). The rules governing this form vary significantly across jurisdictions.
The legal entity. This is where things get interesting. Often these are referred to as companies, businesses, or corporations, but this is a mistake. “Company” and “business” are ill-defined terms, one which brings to mind the idea of a factory, a shop, a service, a restaurant. Today, these nearly always have a legal entity associated with them, to ensure the owners and managers are not liable for the debts of the enterprise, and to allow the enterprise to survive changes in ownership, management, or scope.
However, it is perfectly possible for a legal entity to conduct no business at all, as is the case with legal entities set up, for example:
- to ring-fence assets and liabilities;
- for regulatory arbitrage;
- to minimize tax;
- to obfuscate the control, nature or finances of the organisation, as in organised crime, money laundering, corruption and fraud;
- to organise the complex activities of a modern multinational corporation (see the declared significant subsidiaries of Salesforce)
There are four key features typically associated with legal entities, which makes them incredibly powerful.
1. Distinct legal personality
The first we have already mentioned: legal personality distinct from the owners and managers of the entity. This is the key feature, as it effectively allows the legal entity to act as an avatar or proxy for the owners. The entity can employ people, own assets (property, IP, loans to others, etc), have liabilities (owe money, have contractual or legal obligations), break the law, but critically cannot be put in jail. And all the time, except in the very rarest of cases the owners and managers are not personally liable. They get the rewards, but feel none of the pain.
Even in the very rare situations where owners are found to be personally liable, this requires the judgement to be enforceable, which is often not the case if the owner is in another jurisdiction, especially one which is either hostile to the jurisdiction of the judgement (e.g. North Korea), or where judgements in other jurisdictions cannot be enforced.
2. Universal recognition
In legal parlance, this is known as comity, but effectively it means that if you form a legal entity in one jurisdiction it will be recognized by other jurisdictions. This is very powerful, for multiple reasons: first, it means that you can form a legal entity in, say, the British Virgin Islands and it will be recognized by the courts in the US, UK, France, or wherever. Second, as a consequence of this, it means that your legal entity/avatar can scale its activities massively, anywhere around the world. Third, it means that aspects of the legal entity that would not be permitted in the local jurisdiction (e.g. bearer shares, legal entities as directors, etc) can be bypassed just by incorporating in a jurisdiction that does.
3. Chainability
The third key feature is the ability to chain legal entities together. One legal entity (the parent) can own another legal entity (the subsidiary), and these can be in different jurisdictions. This adds a level of complexity to the structure, making it hard to analyse (if you are lending it money, or considering investing in it), particularly as these different entities might have complex legal arrangements between them (loans, licensing of IP from one entity to another, etc). It also allows entities to play off the rules in one jurisdiction against another, allowing complex tax arrangements like the Double Irish With Dutch Sandwich, which allowed Apple to avoid paying billions in tax that would otherwise have been due.
It also allows a series of “firewalls” to be created in the structure – have one entity in a “secrecy jurisdiction” that prevents seeing who controls it, another entity which has favourable tax laws that shields profits from being taxed, and another that has a favourable regulatory regime for an activity.
4. Limited liability
Limited Liability means that the owners (shareholders, members and the like) are only liable to the extent they invested in the entity, and not for any debts or liabilities above and beyond this. This feature is usually highlighted as a key feature of legal entities, but it is worth noting that it is not a requirement (unlimited liability legal entities exist and are used by some significant financial market players), and it is arguably the least important aspect in legal entities used for illicit purposes.
Why?
First, even if owners are liable, you still have to recover the money, which means you have to find out who they are, and then have courts with power enforce its payment. Unless you are in the same jurisdiction as the entity, and the owners and their assets are too, good luck with that.
Second, in those territories that allow them, as an owner, all you need to do is put a limited liability legal entity between you and the unlimited one, and you still have the limited liability protection (in the UK, for example, you lose some of the opacity benefits, but can retain flexibility of share capital and also can get some tax benefits).
What does all this mean?
When you contract with a legal entity, you are relying on that entity’s legal personality to give the agreement meaning. You are trusting that the entity exists, that it has the capacity to enter the contract, that obligations undertaken will attach to something capable of fulfilling them, and that if something goes wrong, you will have recourse against something capable of being held to account.
But an enforceable contract depends on more than legal personality in the abstract. It depends on the specific rights available in the governing jurisdiction – and, critically, on the practical ability to enforce them. Legal personality gives a contract its theoretical foundation. Jurisdiction and enforceability determine whether that foundation holds weight in the real world.
Entity identification is not a technical nicety. It is not a compliance checkbox or an administrative detail. It is the bedrock upon which enforceable commerce rests.
The digitalization of global trade makes this foundation more important than ever. When agreements are executed in milliseconds, when transactions propagate across interconnected systems, when smart contracts execute automatically – there is no room for ambiguity about who the parties are. The entities involved require clear, unambiguous identification.
Yet despite the central importance of legal entities to commerce, the world has never had a universal, reliable way to identify them. That gap has consequences for everyone who participates in the global economy.
We have only scratched the surface here. The nature of legal entities – what they are, how they vary across jurisdictions, and what those variations mean for the people who depend on them – is a richer and more consequential subject than any single post can do justice to. We will return to these questions throughout this series.
In the next post, we will look at how a legal entity actually comes into being – the process that grants it “life”.
OpenCorporates and the plei are not affiliated with and operate independently of the Global LEI System and the Global Legal Entity Identifier Foundation (GLEIF).
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