Faculty of Management and Human Resource Development SHC 2723 Company Law

Salomon v A. Salomon Co. Ltd [1987] AC 22 (House of Lords)

Lecturer: Puan Suzana Binti Sudin

Name: Tan Kah Lim Section: 2 Matric Number: AH090339 I/C Number: 890211085938

Case: Salomon v A. Salomon Co. Ltd [1987] AC 22 (House of Lords)

1.0 Legal Principle The legal principle which indicated in the case of Salomon is - a company is a separate legal entity. The company created by Salomon is a business organization that is incorporated (or registered) under the Companies Act. The company is a separate legal entity and exists separate from its members. The distinction between a company and its members as different legal persons can be called as the veil of incorporation. The veil of incorporation protecting the personal assets of owners from lawsuit by ensures that a company is a separate legal entity from its directors and shareholders. The incorporation of a company is an artificial entity recognized by the law as a legal person that exists independently with rights and liability. The company takes its responsibilities itself, owners are free from their personal liabilities and owners enjoy limited personal liability (risk) only up to their investments in stocks, though there may be certain situations where their personal responsibilities can exceed from limited liability concept. The company can sue and on the hand be sued in the companys name, it hold its own property and liable for its own debts. This can be said that the shareholder hold limited liability, and therefore, is not liable for the debts that belong to the company. The company not to be regarded as an agent of the owner, as the company is at law a different person altogether from the subscribers to the memorandum and the company is not in law the agent of the subscribers or a trustee for them. The issue from Salomon case is whether Salomon liable to the debts or not. How the court applied the principle of a company is a separate legal entity in determining Salomon should pay the debts on behalf of the company or not? How important of that principle in this case?

2.0 Facts Aron Salomon was a leather boot and shoe manufacturer who carried on of his business as a sole proprietor for 30 years prior to 1892. Since his sons wanted to become owners for the business, he turned the business into a limited company in 1892. He sold his business to the new company (the company, he was planning to form) as he knew that the company is separate legal entity. The Companies Act 1862 (UK) required a minimum of seven associated persons before a new company could be registered. He set up a company with seven shareholders (Salomon, his wife and daughter, and four sons). Salomon was managing director while two of his sons became directors. Salomon owned 20,001 of the company's 20,007 shares (1 each) - the remaining six were shared individually between the other six shareholders. Salomon sold his business to the new company for almost 39,000, of which 16,000 was to be paid in cash or debentures (6,000 in cash and 10,000 in debentures). He became principal shareholder and principal creditor of the company at the same time. After a year, the company got into difficulties. Salomon and his wife lent money to the company. In an attempt to keep the company going, Salomon had the company cancel his 10,000 debentures and re-issue it to Broderip who paid him 5000 for it. He immediately lent the 5000 to the company. But the business still failed, the company went into liquidation after he failed to pay the interest due to Broderip on his 10,000 debentures. The sale of the companys assets in the liquidation realized enough to pay Broderip but not enough to pay the 10,000 debentures and the unsecured creditors of the company. This caused the companys liquidator sought to hold Salomon responsible for all of the companys debts. The liquidator met Broderips claim with a counter claim, joining Salomon as a defendant, the liquidator argued that the debentures used by Salomon as security for the debt were invalid, because of fraud. The liquidator claimed for 20,000 back that was transferred when the company was started: rescission of the agreement for the business transfer itself, cancellation of the debentures and repayment of the balance of the purchase money. The High Court and Court of Appeal held that Salomon must indemnify the company that is he has to pay the debts owed to creditors on behalf of the company. The High Court held that

Salomon was liable for the debts because the company was his agent. But Salomon didn't agree, he appealed to the Court of Appeal. Court of Appeal also held that Salomon was bound to indemnify the company's debts because the company was a trustee for Salomon. This time Salomon appealed to the House of Lords (highest court). The House of Lords by a majority held that Salomon did not have to pay to the companys creditors since the company is not the agent or trustee to Salomon and the company is separate from its members. 3.0 Court Decisions 3.1 High Court In the first case, Broderip v Salomon, the judge, Vaughan Williams J, held that the liquidators claim was valid. Salomon must indemnify the company. It was undoubted that the 20,000 shares were fully paid up. Since Salomon had created the company solely to transfer his business to it, the company was in reality his agent and he was responsible to pay the debts to unsecured creditors. 3.2 Court of Appeal The Court of Appeal also held that Salomon must indemnify the company's debts. The Court of Appeal felt that Salomon was a fraud and he had abused the privileges of incorporation and limited liability. The court said that Salomon only found six people (his wife and five children) to form the company and those six people are just nominees of Salomon. The six shareholders were not independent and this meant that the company was conducting the business on behalf of Salomon, thus the company was not doing so as agent but as a trustee for Salomon. Hence, he was legally responsible to pay the amount of the unsecured debts. 3.3 House of Lords The House of Lords do no agreed with the judgments made by the High Court and the Court of Appeal. The majority of them held that Salomon do not need indemnify the companys debts due to the company was not the agent or trustee to him and the company was separate from its owners.
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Lord Halsbury, L.C said that either the limited company was a legal entity or it was not. If the company was a legal entity, the business belonged to it and not to Salomon. If the company was not a legal entity, there was no person and no thing to be an agent at all. It is impossible to say at the same time that there is a company and there is not. He found that Salomon not do anything that was dishonest and unworthy. He said that there is no evidence to show that there should assign a charge of fraud against Salomon. Lord Watson said that the creditors of the company should search the Companies Register to make certain the names of the shareholders and the number of shares the shareholders was in hand. However the failure to do this should not assign a charge of fraud against Salomon. Lord Herschell looked at the purpose of the statute in that it sought to protect shareholders by limiting their liability. He noted the potentially "far reaching" implications of the Court of Appeal's logic and that in recent years many companies had been set up in which one or more of the seven shareholders were "disinterested persons" who did not make use of any influence over the management of the company. Anyone dealing with such a company was aware of its nature as such, and could by consulting the register of shareholders become aware of the breakdown of share ownership among the shareholders. Lord McNaghten had made the statement which meant that once a company is incorporated, it is a separate legal entity distinct from the members and clothed with a veil of incorporation. Thus, the company is regarded as a separate legal person and having its own rights and liabilities. The limited companys members enjoy limited liability. So, Salomon not indemnify to the company. Lord Davey considered that it was probable that the result would not have been expect by the legislature and might have been due to a defect in the legislation. He also mentioned that it was not argued that there was no association. He was impressed with the absence of a trust and rejected the arguments based on fraud. Lord Morris simply agreed with the others.

4.0 Application in Malaysia 4.1 Hotel Jaya Puri Bhd v National Union of Hotel, Bar & Restaurant Workers (19501985) MSCLC 282 The Jaya Puri Chinese Garden Restaurant Sdn. Bhd. was closed down due to losses. A number of workers employed were retrenched by the Company and the workers contracts were terminated. The restaurant was carried on in premises belonging to the Hotel Jaya Puri Bhd. and both the hotel and the restaurant had the same managing director. A dispute arose between the workers and the restaurant and the dispute was referred to the Industrial Court. The industrial court found on the fact that the hotel was the employer of the workers and awarded two months salaries plus fixed allowances as compensation. The hotel applied to the High Court to quash (cancel) the award. Thus the issue arise here is whether the award should be quashed or not. The High Court held that the judgment of Industrial Court did not cause any violence to the principle of separate entity established in Salomon case but rather gave effect to the reality of the hotel and the restaurant as being in one enterprise. This means that although technically the restaurant and the hotel were separate legal entities in reality the two companies were functionally one. The court is willing to lift the veil of incorporation "when the justice of the case so demands" and that on the facts of the instant case there was the essential unity of a group enterprise and the restaurant and the hotel ought to be treated as a single unit. The High Court held that the termination of the service of the workers was proper and there was no legal basis for the award of compensation to the workers. There was an error on the face of the record and thus the award should be quashed. The termination of service of these workers could not be considered as dismissal and compensation awarded could not be on the basis of dismissal.

The basic principle is that once the company has been incorporated (a separate legal entity), the court will not go beyond the veil of incorporation. But the concept of a company being a separate legal entity can sometimes give undesirable results. In particular, shareholders could

use a company to obtain funds dishonestly, and then not be liable for repayment. There are therefore numerous exceptions (lifting the veil) to the rules defined by Salomon case. These can be implemented by the courts on a case-by-case basis, or by statute. One of the exceptions implemented by the court is when the entities are considered to be a single unit. The High Court in this case found on the fact that the restaurant and the hotel were functionally one (single unit), so the court going to lifting the veil of the incorporation to see deeply whether the hotel should compensation or not.

4.2 Aspatra Sdn Bhd & 21 ors v Bank Bumiputra Malaysia Bhd & anor [1988] MLJ 97

The case involved applications for an Anton Piller order and a Mareva injunction to prevent removal from the jurisdiction of assets owned by Lorrain Esme Osman, who was at all times a director of Bank Bumiputra Malaysia Berhad and its wholly owned Hong Kong subsidiary, Bumiputra Malaysia Finance Ltd. The bank had a claim against Lorrain for the return of moneys which the bank claimed were secret profits made by Lorrain without their knowledge and approval, arising from transactions with Hong Kong companies. The trial judge had granted the Mareva injunction against Lorrain and five companies, on the basis that the assets of those five companies (including Aspatra Sdn Bhd) were the assets of Lorrain. The issue from this case is to determine whether Lorrain should return the moneys to the bank. The Supreme Court of Malaysia lifted the veil of incorporation to ascertain the actual ownership of assets in granting a Mareva injunction. The Court could lift the veil to determine whether the assets of the company were really owned by them or whether there was an abuse of the principal that a company is a separate legal entity (as published in Salomon case).

The Supreme Court noted that the only reason of proceeding against the appellant companies was to lift the corporate veil, so that the assets of the companies could be considered to be the assets of Lorrain. Further, the court noted that only small amount of shares in the relevant companies did not belong to Lorrain, and he was a director in 15 of the 22 companies. The Court held that the trial judge had been correct to lift the corporate veil between the companies and Lorrain. Clearly in this case the possibility that Lorrain had hidden funds dishonestly acquired in corporate entities was sufficient to convince the court to raise the corporate veil, particularly in view of the almost absolute control he maintained over the companies in question.

4.3 Abdul Aziz Bin Atan & 87 ORS v Ladang Rengo Malay Estate Sdn. Bhd. (1985) 2 MLJ 165 The company (Ladang Rengo Malay Estate Sdn. Bhd.) owned an estate where the plaintiff (Abdul Aziz Bin Atan & 87 ORS) was employed. This case happens when all of the shareholders of the company actually sold and transferred their share holding to a certain buyer (Gemas Bahru Estate Sdn Bhd). The problem arises here is that whether the sales and transfer of the company's share result to the sales in the estate. The court had to determine whether the estate was sold and if so whether a change of employer took place. The company is an incorporated company. An incorporated company is a separate legal entity and distinct from its shareholders. The company, from the date of incorporation, has an effect of perpetual succession and did not change its identity or personality even though the entire share holding of the company changed hands. The companys members may come and go but this does not affect the legal personality of the company. The company continues to exist until its name is struck off or dissolved through a legal process known as winding up or liquidation even though there have change in directors, members, employees, and business. Thus, a change in the ownership of the estate did not take place. This case had applied the legal principle which prevailed in the Salomon case, which is a company is a separate legal entity. Both of the case had proved the consequences of the companys corporate personality. The Salomon case had proved that company is responsible for its own debts and contractual obligation while this case had prove that a company has perpetual succession because of the company in both case was a separate legal entity.