SALOMON V A SALOMON & CO LTD

SABA KHAN

SP17-BBA-037
 SALOMON V A SALOMON

ABSTRACT
The ‘rigid construct’ of company law, Salomon v A Salomon, established a
century-old principle, that is, the separate juristic personality of a corporation, out
of which ‘the legal structure of modern business’ was born; and, the so called
corporate veil remains unchallenged. This unyielding rock protects shareholders’
private assets and provides a method of limitation of liability which is acceptable
by company law in order to facilitate business development and international trade.
A rigid application of the principle, however, may sometimes cause damage to the
rights of parties who deal with the corporate because its controllers may be using
the corporate structure as a façade to perpetrate wrongdoing.
Thus the court therefore provided various exceptions to the rule, which
allows for the ‘lifting of the veil’ of the rigid construct as provided for in Salomon
v. Salomon. These exceptions have been a basis for continuous debate amongst
legal scholars as to whether they render the century-old principle out of place and
relevance in modern company law.
INTRODUCTION
The general rule in relation to companies is that a company is an artificial
person, separate and distinct from its directors and shareholders, and neither the
directors nor shareholders are personally liable for the defaults of the company
(save in special narrowly defined circumstances, which form specific exceptions to
the general rule).
FACTS OF THE CASE
Mr. Salomon carried on a business as a leather merchant. In 1892, he formed
the company “Salomon and company Ltd”. Mr. Salomon, his wife, and five of his
children held one share each in the company. The members of the family held the
shares for Mr. Salomon because the Companies Act required at that time that there
be seven shareholders. Mr. Salomon was also managing director of the company.
The newly incorporated company purchased the sole trading leather business.

The leather business was valued by Mr. Salomon at ₤39,000. This was not
an attempt at a fair valuation; rather, it represented Mr. Salomon’s confidence in
the continued success of the business.

This price was paid in ₤10,000 worth of debentures, giving a chance over all
the company’s assets. ₤20,000 shares of ₤1 each, the balance of ₤9,000 was paid to
Salomon in cash. Mr. Salomon also at this point paid off all the sole trading
business creditors in full. Mr. Salomon thus held 20,001 shares in the company and

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his family held the 6 remaining shares. He was also, because of the debenture, a
second creditor.

Therefore, Mr. Salomon’s personal liability for the debt of the business had
changed completely from unlimited liability to limited liability. Not only was Mr.
Salomon no longer liable personally for the debt of the company, but he had also
as managing director of the company granted himself a secured charge over all the
company’s assets. Thus, if the company failed, not only would Mr. Salomon
have no personal liability for the debts of the company, but whatsoever assets
were left, would be claimed by him to pay off the company’s debt to him.

Things however did not go well for the leather business, and within a year,
Mr. Salomon had to sell his debenture to save the business. This did not have the
desired effect, and the company was placed in insolvent liquidation. The liquidator
on behalf of the unsecured creditors alleged that the company was a mere “alias”
or agent for Mr. Salomon, and that Mr. Salomon was therefore personally liable for
the debt of the company.

JUDGMENT OF THE COURT OF APPEAL

In the circumstances of the case, Vaughan Williams, J. and a strong Court
of Appeal held that the whole transaction was contrary to the true intent of the
Companies Act and the company was a mere sham, and an “alias”, simulacrum,
agent, trustee of the nominee Salomon who remained the real proprietor of the
business. As such, Salomon was liable to indemnify the company against its
trading debts.
JUDGMENT OF THE HOUSE OF LORDS
Famously and quite seminally, the House of Lords by a slim majority of 3/2
disagreed with the judgment of the Court of Appeal. It found that the fact that
some of the shareholders only held shares as a technicality was irrelevant; the
machinery of the Companies Act could be used by an individual to carry out what
is in economic reality for his or her business.

It also emphasized that a company formed in compliance with the regulation

of the Companies Act is a separate person and not per se the agent of its controller.
The decision also affirmed that the use of debentures instead of shares can further
protect investors. The House of Lords unanimously overturned this decision,
rejecting the arguments from agency and fraud.

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Salomon followed the required procedures to set the company; shares and
debentures were issued. The House of Lords held that the company has been
validly formed since the Act merely required 7 members holding at least one share
each. There was no fraud as the company was a genuine creature of the Companies
Act as there was compliance and it was in line with the requirements of the
Registrar of Companies.

DIFFERENCES BETWEEN CORPORATE PERSONALITY AND

LIMITED LIABILITY

In light of having established corporate personality and limited liability as

the twin pillars upon which modern company law rests, it is trite to distinguish
between the two concepts as they are not one and the same thing.

Limited liability is the logical consequence of the existence of a separate

personality. It is a corollary of corporate personality. It is important to appreciate
the fact that as human beings can have restrictions imposed on their legal
personality, so also can a company have legal personality without limited liability
if that is how it is conferred by the statute. That is, a company may be registered as
an unlimited company, without having the benefit of limited liability. This is
however rare.

The logic of corporate personality and limited liability was not tested to its
full extent until the late 19th century as some notable cases demonstrate and
exemplify. As a result of this, limited liability is available both to small scale and
large scale businesses.

LEGAL CONSEQUENCES OF INCORPORATION

 As has been established, once a company has complied with the provisions
of the Companies Act, it will be incorporated. The incorporation of the company
leads to the company becoming an artificial person in law, a legal person distinct
from the shareholders. The following attendant legal consequences will follow;
1.     Perpetual Succession and Existence

Since a company is an artificial person, it is not susceptible to the vicissitudes of

the flesh. It cannot become incapacitated by illness, mental or physical, and does

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not have an allotted span of life. It has perpetual succession or existence regardless
of any changes that may take place in the membership as a result of death,
retirement or any other reason whatsoever. Therefore, while the death of any
individual businessman may put an end to his business and the death of a partner
may automatically dissolve the partnership, incorporation ensures continuity of the
business of the company.

Even if during a war all the members of one private company while in a
meeting were killed by a bomb or where the only two members were killed in a
road accident, the company continues to exist! The concept of perpetual succession
may be limited by the provisions of the articles, for instance Section 457 of the
Companies and Allied Matters Act provides that a company may be wound up
voluntarily when the period, if any, occurs on the occurrence of which the articles
provide that the company is to be dissolved and the company in general meeting
has passed a resolution requiring so, the company would be wound up. The
company can also be wound up voluntarily.

2.     Limited Liability

Since the company is a separate person from the members that owns it, its
members are as such not liable for its debts. Hence, in the absence of express
provision to the contrary the company is wholly liable for all its debts and
obligations up to the full extent of its liability and assets. Such a company can
either be registered as unlimited in which case the members are in effect guarantors
of its obligations without any restriction on the amount.

In the case of a company limited by shares the liability of the members is

limited to any amount remaining unpaid on the shares held by them. In the case of
a company limited by guarantee each member is liable to contribute a specified
amount to the assets of the company in the event of its being wound up while he is
a member. In the case of unincorporated bodies, the position is like that of
partnership and consequently the liability of the association is that of the individual
members. The practical significance of such limitation of liability is that it defines
the extent of investment risk and loss. It also provides a means of escape from risk
of loss to big or small traders thereby insulating them against execution extending
to their personal estates. It also insulates members from liability for corporate debts

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and obligations. This has facilitated the existence of one-man companies or family
concerns.

3.     Property
One of the obvious advantages of corporate personality is that it enables the
property of the association to be clearly distinguished from that of its members. In
an unincorporated society, the property of the association is the joint property of its
members. Since a company can act as an ordinary person, it can enter into
contracts through its authorized person(s).
Therefore it can be a beneficial owner of its property. It in no way holds
trust for its members and they have no interest in it except such interest that goes
with the membership of the company in Macaura v. Northern Assurance Co it was
held that property of the company belongs to it and not to the individual members,
so that even if its largest shareholder has no insurable interest in the property of the
company.
4.     Right to Sue and be sued
Another important character which flows from the legal entity concept is the
right of the company to sue and its liability to be sued. The company as a legal
person can take action to enforce its own name. That is, all legal proceedings must
be commenced and prosecuted in the name by which a company is registered.

This avoids the resorts to the rather circuitous course of representative

actions which most unincorporated bodies adopt. The rule which follows from this
is that the company alone can maintain an action in respect of an injury or wrong
done to it, as enunciated in the case of Foss v. Harbottle
5.     Transferable Shares
A share in a company constitutes a personal proprietary interest which is
transferable with the effect that the transferor drops out and the transferee drops in
and assumes his rights and obligations in respect of the shares transferred. A
registered company under the Companies and Allied Matters Act is free to transfer
is shares freely as any other personal estate, but it must be done in a manner
provided for in the articles of association.
Where however, there is duty to offer the shares to the members then the
transferor must offer the shares to the already existing shareholders first. It is to be
noted that in relation to private companies, Section 22(2) of the Companies and
Allied Matters Act restrict the transfer of shares to the public. Such restriction in

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any event, is desirable if such a company is to retain its characters of an

incorporated private partnership.

These attributes when added to the access to credit by the issue of floating
charges make the corporate form of enterprise a very advantageous and attractive
organization for economic activity at least from the point of view of members.

 
ADVANTAGES OF LIMITED LIABILITY

Limited Liability, which has been established above as being different from
Corporate Personality, yet a corollary of same, has certain advantages. They are;

·        Risk is minimized for the Investors;

·        Management are freed up to take greater risk;

·        It allows the public price of shares to be easily determined;

LIFTING THE CORPORATE VEIL

In view of above discussion, the chief advantage of incorporation from

which all others follow is, of course, the separate legal entity. In reality, however,
the business of the artificial person is always carried on by, and for the benefit of,
some individuals. In the ultimate analysis, some human beings are the real
beneficiaries of the corporate advantages.

It may, therefore, happen that the corporate personality of the company is

used to commit frauds or improper illegal acts. Since an artificial person is not
capable of doing anything illegal or fraudulent, the facade of corporate
personality might have to be removed to identify the persons who are really
guilty. This is known as lifting the corporate veil.

Although, in general, the courts do not interfere and essentially go by the

principle of separate entity as laid down in the Solomon’s case as discussed above.

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However, with the passage of time, the courts come to realize that there can
be fraudulent and mischievous schemes drawn by the promoters and members of
the companies and the principle of Solomon’s case cannot be extended to each and
every company. It may be in the interest of members in general, or in public
interest to identify and punish the persons who misuse the medium of corporate
personality. The circumstances under which the courts may lift the corporate veil
may broadly be grouped under the following two heads:

  LIFTING OF THE CORPORATE VEIL BY STATUTE

The veil of corporate personality may be lifted in certain cases or pierced as per
express provisions of the company law. In other words, the advantage of ‘distinct
entity’ and ‘limited liability’ may not be allowed to be enjoyed in certain
circumstances. Such cases may be:

1. Reduction of membership: If at any time, the number of members is reduced

below the statutory minimum, and the companies carries on business beyond
that minimum while the number is so reduced, the law can pierce the corporate
veil under the relevant law and makes persons behind the company personally
liable (in spite of their limited liability otherwise).

2. Misrepresentation in prospectus: In case of misrepresentation in a prospectus,

every director, promoter and every other person, who authorizes such issue of
prospectus, incurs liability toward those who subscribed for shares on the faith
of untrue statement.

3. Mis-description of name: Where officer of a company signs on behalf of the

company any contract, bill of exchange, or any kind of order of money, such
person shall be personally liable if the name of the company is either not
mentioned, or is not properly mentioned.

4. Fraudulent conduct: Where in case of winding up of the company by

members of the company, it appears that any business of the company has been
carried on with intent to defraud creditors of the company, or any other person,
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or for any fraudulent purpose, the court may hold such persons liable personally
for any liability of the company.

5. Liability for ultra vires acts: Directors and other officers of a company will be
personally liable for all those acts which they have done on behalf of a
company if the same are ultra vires of the company

CONCLUSION
In more than a century since Salomon v. Salomon & Co. Ltd. was decided, various
exceptional circumstances have been identified, both by legislatures and the
judiciary, as to when courts can legitimately disregard a company’s distinct legal
personality and “pierce the corporate veil”, such as where a fraud has been
committed.
But the basic premise of the judgment in Salomon v Salomon & Co. Ltd. remains
unaltered today; a limited liability company is a legal person, separate and
distinct from the members or directors and it. Furthermore, the principle
enunciated in Salomon v, Salomon is NOT outdated, and still has relevance in
modern company law.

In summary, it could be said that the courts will never lift the veil to impose
liability on a shareholder for the company's debts. Nor they will lift the veil to
benefit shareholders who would discover that trading as a company would be a
disadvantage. In some (rare) instances, the courts will have a look at the substance

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rather than at the form to deny benefits of corporate status which they think should
not be enjoyed.

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