Salomon v Salomon

NATURE OF COMPANY

FACTS

Salomon transferred his business of boot making, initially run as a sole proprietorship, to a
company (Salomon Ltd.), incorporated with members comprising of himself and his family. The
price for such transfer was paid to Salomon by way of shares, and debentures having a floating
charge (security against debt) on the assets of the company. Later, when the company’s business
failed and it went into liquidation, Salomon’s right of recovery (secured through floating charge)
against the debentures stood aprior to the claims of unsecured creditors, who would, thus, have
recovered nothing from the liquidation proceeds.

To avoid such alleged unjust exclusion, the liquidator, on behalf of the unsecured creditors,
alleged that the company was sham, was essentially an agent of Salomon, and therefore,
Salomon being the principal, was personally liable for its debt. In other words, the liquidator
sought to overlook the separate personality of Salomon Ltd., distinct from its member Salomon,
so as to make Salomon personally liable for the company’s debt as if he continued to conduct the
business as a sole trader.

ISSUE

The case concerned claims of certain unsecured creditors in the liquidation process of Salomon
Ltd., a company in which Salomon was the majority shareholder, and accordingly, was sought to
be made personally liable for the company’s debt. Hence, the issue was whether, regardless of
the separate legal identity of a company, a shareholder/controller could be held liable for its debt,
over and above the capital contribution, so as to expose such member to unlimited personal
liability.

RULING

The Court of Appeal, declaring the company to be a myth, reasoned that Salomon had
incorporated the company contrary to the true intent of the then Companies Act, 1862, and that
the latter had conducted the business as an agent of Salomon, who should, therefore, be
responsible for the debt incurred in the course of such agency.

The House of Lords, however, upon appeal, reversed the above ruling, and unanimously held
that, as the company was duly incorporated, it is an independent person with its rights and
liabilities appropriate to itself, and that “the motives of those who took part in the promotion of
the company are absolutely irrelevant in discussing what those rights and liabilities are”.3 Thus,
the legal fiction of “corporate veil” between the company and its owners/controllers4 was firmly
created by the Salomon case.
 Jones v Lipman [1962] 1 WLR 832

LIFTING THE COMPANY VEIL

Facts

 Mr Lipman contracted to sell a house with freehold title to Jones for £5,250.00.
 Pending completion, Lipman changed his mind and instead sold and transferred the
land to a company, which he and a law clerk were the sole directors and shareholders
of, for £3,000.00.
 The company had been set up for the sole purpose of receiving this land.
 $1,554.00 of the £3,000.00 was borrowed by the company from a bank and the rest
remaining owing to Lipman.

Issues

 Was Lipman’s company an attempt to avoid a pre-existing legal obligation?

Held

 The English High Court held that the company was a sham or facade which Lipman
intended to use to evade a pre-existing obligation.

Quotes

“The defendant company is the creature of the first defendant, a device and a sham, a

mask which he holds before his face in an attempt to avoid recognition by the eye of

equity.”
Concerning piercing the corporate veil. It exemplifies the principal case in which the

veil will be lifted, that is, when a company is used as a "mere facade" concealing the

"true facts", which essentially means it is formed to avoid a pre-existing obligation.

H L Bolton (Engineering) Co Ltd v T J Graham & Sons Ltd [1957]

COMPANY MIND
Facts
T J Graham & Sons Ltd (TJG) leased their premises to H L Bolton (Engineering) Co Ltd (HLB) in 1941.
HLB sublet their premises in a similar lease.
In 1954, TJG notified HLB that the lease would be terminated that year, and HLB gave their sub-tenants
similar notice.
Both notices were rendered ineffective by the enactment of the Landlord and Tenant Act 1954 (UK) (the
Act).
TJG gave the sub-tenants notice of termination under the Act in 1954 and opposed their application for a
new tenancy under section 24(1) of the Act.
The subtenants argued that they had “purchased” their interest in the premises within 5 years before
termination.
TJG argued that they were going to be occupying the premises to conduct business.
No formal resolution from a directors meeting at been passed by TJG to this effect, but the company had
been moving this way in other aspects (meeting with architects, etc.).
Issues
Were TJG entitled to oppose the sub-tenants application on the grounds of occupying the premises to
conduct business?
Held
TJG were entitled to occupy the premises for the purposes of conducting business.
The sub-tenants had not “purchased” their interest – they had provided no consideration when HLB
surrendered the lease. Under the Act, consideration was said to be “bought for money”.
Despite TJG not formally passing a resolution because, having standing to the directors in charge of the
business, the intention of the directors was the intention of TJG.
It was clear that TJG intended to occupy the land for the purposes of conducting business.
Quotes
“A company may in many ways be likened to a human body. It has a brain and nerve centre which
controls what it does. It also has hands which hold the tools an act in accordance with directions from the
centre. Some of the people in the company are mere servants and agents who are nothing more than
hands to do the work and cannot be said to represent the mind or will. Others are directors and managers
who represent the directing mind and will of the company and control what it does. The state of mind of
these managers is the state of mind of the company and is treated by law as such. So you will find that in
cases where the law requires personal fault as a condition of liability in tort, the fault of the manager will
be the personal fault of the company …So also in the criminal law, in cases where the law requires a
guilty mind as a condition of a criminal offence, the guilty mind of the directors and managers will render
the company itself guilty.”

Phonogram Ltd v Lane [1982]

PRE-IMCORPORATION CONTRACT
A rock group intended to perform under the name "Cheap Mean and Nasty" and to form a company for
the purpose to be called "Fragile Management Ltd". Mr Lane accepted a cheque from Phonogram for
£6,000, signing his name "for and on behalf of Fragile Management Ltd". The money was to be used to
finance production of an album and was repayable if this was not achieved. When the album was not
produced, Phonogram sought to recover the money from Lane, the company having not been in existence
at the time the contract was made. Lane argued that his signature "for and on behalf of" the company
amounted to an agreement that he was not to be personally liable on it - an "agreement to the contrary" in
terms of s.36C. (Then s.9(2) of the European Communities Act 1972).
Held: This was not sufficient to exclude the operation of the section, which would be given full effect
unless there was a clear and express exclusion of personal liability. Lane was thus liable to repay the
money. Refusal to Register

Ooregum Gold Mining Co of India v Roper [1892]

DISCOUNTS
Facts
The Ooregum Gold Mining Co of India issued 120,000 shares at £1 each. Shareholders said they wanted
to sell on the shares for 5 shillings, (i.e. 25 new pence) one quarter of the value the shares were issued at,
but that the buyers would be credited with a full £1 in the company. This would mean that shareholders
would get a 15 shilling (75 new pence) discount. At the time of the litigation, the share price stood at £2
14s. The shareholders at the time of the purchase (who now wanted money to pay off a debenture) even
though they had voted for the issue, then turned around to the buyers and argued that shares were
prohibited from being issued at a discount, and that the transaction was void.

Judgment
The House of Lords agreed that shares must not be issued at a discount. It was concerned with the
potential effects on creditors. Although it is arguable that any capital increase would benefit creditors
(hence speaking in favour of not preventing issue at a discount), the Lords held the proper technical route
would be for the company to reduce the nominal value of the shares (as seen in the later case of
Greenhalgh v Arderne Cinemas Ltd[1]). Lord Halsbury LC said the following.
“ the Act of 1862... makes [it] one of the conditions of the limitation of liability that the
memorandum shall contain the amount of the capital with which the company proposes to be registered,
divided into shares of a certain fixed amount. It seems to me that the system thus created by which the
shareholder’s liability is to be limited by the amount unpaid upon his shares, renders it impossible for the
company to depart from that requirement, and by any expedient to arrange with their shareholders that
they shall not be liable for the amount unpaid on their shares. ”
Lord Watson noted that otherwise, ‘so long as the company honestly regards the consideration as fairly
representing the nominal value of the shares in cash, its estimate ought not to be critically examined.’

Guinness Plc v Saunders [1990]

REMUNERATION OF DIRECTORS
Facts
A former director of the recently taken-over Guinness brand was paid a £5.2 million sum as a bonus
The bonus was authorised by a committee of directors
The articles of association provides that the whole board must consent to such a bonus
Issue
Could the bonus be retained?
Decision
No
Reasoning
Breach of fiduciary obligation based on terms set out in the company’s articles of association, which
could not be overruled
The case of Guinness Plc v Saunders [1990] 2 AC 663 is a key decision on directors remuneration. This
case appears to demonstrate that where the Articles determine entitlement for receipt of remuneration then
directors have a right to the same. The Guinness case suggests that the courts generally will not seek to
overrule the Articles and impose reasonable remuneration on a quantum merit basis on an implied
contract.

IDC vs Cooley 1972

FIDUCIARY DUTY
Facts
Mr Cooley was an architect employed as managing director of Industrial Development Consultants Ltd.,
part of IDC Group Ltd. The Eastern Gas Board had a lucrative project pending, to design a depot in
Letchworth. Mr. Cooley was told that the gas board did not want to contract with a firm, but directly with
him. Mr. Cooley then told the board of IDC Group that he was unwell and requested he be allowed to
resign from his job on early notice. They acquiesced and accepted his resignation. He then undertook the
Letchworth design work for the gas board on his own account. Industrial Development Consultants found
out and sued him for breach of his duty of loyalty.
Judgment
Roskill J. held that even though there was no chance of IDC getting the contract, if they had been told
they would not have released him. So he was held accountable for the benefits he received. He rejected
the argument that because he made it clear in his discussions with the Gas Board that he was speaking in a
private capacity, Mr. Cooley was under no fiduciary duty. He had ‘one capacity and one capacity only in
which he was carrying on business at that time. That capacity was as managing director of the plaintiffs.’
All information which came to him should have been passed on.

Held: •C had acted in breach of duty and he must account for the profits he made. IDC might not have
obtained the contract itself was immaterial. •C, while being MD, obtained information and knowledge
that the project was to be revived, deliberately concealed this from IDC, and then took steps to turn the
information to his personal advantage. He put himself in a position in which his duty to IDC who were
employing him and his personal interests conflicted. •As MD he had a duty to pass on the information he
received to IDC. He was liable to account to IDC for the benefits he received under the contracts.

Re City Equitable Fire Insurance Co [1925]

DUTY TO ACT WITHIN POWERS
It is a UK company law case concerning directors' duties, and in particular the duty of care. It is no longer
good law, as it stipulated that a "subjective" standard of competence applied. Now under Companies Act
2006 section 174, and given the development of the common law in Re D'Jan of London Ltd, directors
owe an objective standard of care based on what should reasonably be expected from someone in their
position.
Facts
The company lost £1,200,000 in failure of investments and the large scale fraud of the chairman, Gerard
Lee Bevan, ‘a daring and unprincipled scoundrel’. The liquidator sued the other directors for negligence.
The auditors were sued too, but the Court of Appeal held they were honest and exonerated by provisions
in the company’s articles.

Judgment
High Court
Romer J held that some of the directors did breach their duty of care. But they were not liable to
reimburse, because an exclusion clause for negligence was valid. And even in absence of exclusion
clauses, in his view, ‘for a director acting honestly himself to be held legally liable for negligence, in
trusting the officers under him not to conceal from him what they ought to report to him appears to us to
be laying too heavy a burden on honest businessmen.’ Though he felt ‘some difficulty’ with the
distinction, negligence would need to be ‘gross’ to visit liability.

Re Smith and Fawcett Ltd

DUTY TO PROMOTE THE SUCCESS OF THE COMPANY
Facts:
Company was formed to takeover business carried on by Smith and Fawcett. The company issued share
capital with shares divided between them as its only directors. Article 10 stated that “directors may at any
time in their absolute and uncontrolled discretion refuse to register any transfer of shares” Fawcett died
and his executors applied to Smith to be registered as members and to have plaintiff (Fawcett's son and
beneficiary) appointed as a director. Smith refused to the registration and appointment but offered to
register shares and buy remaining at price fixed by himself. Fawcett rejected offer - Smith appointed his
solicitor as director and Fawcett again applied to be registered as member. Application rejected and he
sought companies share register rectified by inserting his name as holder of shares.
Held:
“Directors must exercise their discretion bona fide in what they consider – not what a court may consider
– is in the interests of the company, and not for any collateral purpose”. In constructing the relevant
provisions of the articles, it must be borne in mind that one of the rights of a shareholder is the right to
deal freely with his property and to transfer it to whomsoever he pleases. The articles of a company
obviously specify the limits of the directors' power (and their discretions) - however, the directors' powers
are also always limited by their obligation to exercise their power in good faith and for a proper purpose.
Here, art 10 gives directors an uncontrolled and absolute discretion and the director’s refusal to issuethe
shares was a bona fide consideration of the interests of the company - appeal dismissed.

Dorchester Finance Co v Stebbing [1989]

DUTY TO PROMOTE THE SUCCESS OF THE COMPANY
DUTY TO EXERCISE REASONABLE CARE
is a UK company law case under the wrongful trading provision of the Insolvency Act 1986 s.214. The
director of a company must act in good faith and in the interests of the company, he must display such
skill as may reasonably be expected of a person with his knowledge and experience, and he must at all
times take such care as a prudent man would take on his own behalf.
Facts
Dorchester Finance, which had gone insolvent, made a claim against Mr Stebbing and two other non-
executive director accountants who often signed blank cheques which were later countersigned by Mr
Stebbing.
Judgment
Foster J held that directors of a company were bound to act in good faith and in the interests of the
company (see now, s.172 Companies Act 2006). They also had to display such skill and care as should be
reasonably expected from people with their knowledge and experience (see now, s.174 Companies Act
2006). The system of signing blank cheques was held to be negligent, and liable for losses under s.214 IA
1986.
Furthermore, no distinction should be drawn in principle between an executive and a non-executive
director.
Foster J held further that it would not be appropriate for the court to exercise its discretion to relieve the
three directors on the basis that they acted "honestly and reasonably" under s.448 of the Companies Act
1948 (see now s.1157(1) Companies Act 2006).