Group - F

One Mr. Salomon, was a shoe manufacturer and his business was in a very sound
condition. He formed a Company named “Salomon & Company Ltd”. This Company
was formed by him for the purpose of taking over and carrying on his earlier business.
The members of this new company were Salomon himself, his wife, four sons and a
daughter. And the members of the Board of Directors were Salomon and his two sons.
Salomon’s earlier business was transferred to this Company for $40,000. In payment of
this consideration, Salomon took shares of $20,000, and debentures worth $10,000. These
debentures imply that the Company owed $10,000 to Salomon and for the repayment of
this, a charge was created in his favour on the assets of the company. One share was
given to each remaining members of the Salomon’s family. Owing to trade depression,
the company went into liquidation within a year, and it wound up. On the winding up, the
assets of the Company were $6000, and the liabilities amounted to $17,000 (out of which
$10,000 payable to Salomon as secured creditor and $7000 were due to other unsecured
creditors). After paying the amount to Salomon as secured creditor, nothing was left for
unsecured creditors. The unsecured creditors complained that Salomon should not get
anything, rather they should be paid, as it was in fact Salomon, who was himself and his
family behind the company and he couldn’t owe money to himself. Can Salomon get
anything as a secured creditor? Give reasons for your answer.
SOLUTION:

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 could be held liable for its debt, so as to
expose such member to unlimited personal liability.
Accordingly, a company can own property, execute contracts, raise debt, make
investments and assume other rights and obligations, independent of its
members. Moreover, as companies can then sue and be sued on its own name, it
facilitates legal course too.
The information the case lacks is whether the limited company was a legal entity
or it was not. If it was, the business belonged to it and not to Mr. Salomon
It is manifest that the other members of the company have practically no interest
in it, and their names have merely been used by Mr.Salomon to enable him to
form a company, and to use its name in order to screen himself from liability.
In a strict legal sense the business may have to be regarded as the business of
the company; but if anybody were asked, Whose business was it? they would say
Salomon's, and they would be right, if they meant that the beneficial interest in
the business was his.
In a sense, the creditor can only reach him through the company. The liability
does not arise simply from the fact that he holds nearly all the shares in the
company. A man may do that and yet be under no such liability as Mr. Salomon
has come under. His liability rests on the purpose for which he formed the
company, on the way he formed it, and on the use which he made of it. There are
many small companies which will be quite unaffected by this decision. But there
may possibly be some which, like this, are mere devices to enable a man to carry
on trade with limited liability, to incur debts in the name of a registered company,
and to sweep off the company's assets by means of debentures which he has
caused to be issued to himself in order to defeat the claims of those who have
been incautious enough to trade with the company without perceiving the trap
which he has laid for them.
Since Mr. Salomon had created the company solely to transfer his business to it,
then the company and Salomon were one unit; the company was in reality his
agent and he as principal was liable for debts to unsecured creditors. It can be
inferred that the incorporation of the business by Mr. Salomon had been a mere
scheme to enable him to carry on as before but with limited liability. The
Company Act created limited liability companies as legal persons separate and
distinct from the shareholders.
They held that there was nothing in the Act about whether the subscribers (i.e.
the shareholders) should be independent of the majority shareholder. It was held
that either the limited company was a legal entity or it was not. If it were, 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.
Hence the business belonged to the company and not to Salomon, and Salomon
was its agent. The company is at law a different person altogether from the
shareholders 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 received the profits, the company is not in law the agent of the
shareholders or trustee for them. Nor are the shareholders, as members, liable in
any shape or form, except to the extent and in the manner provided for by the
Act.
In conclusion, under the light of separate legal personality, Salomon being a
secured creditor deserves the right to be paid off to the extent of his security
invested in the business. It is the company, the unsecured creditors can sue.