This case analysis is written by Khushboo Bharti, BALLB(Hons) 3rd year,Institute of Law,Jiwaji University,Gwalior during her internship with Le Droit India.
1. Case Name and Citation:
Title of the Case: Salomon v. A. Salomon & Co. Ltd.
Court: House of Lords (United Kingdom)
Year: 1897
Citation: [1897] AC 22
2. Facts of the Case:
In this case, special attention will focus on the most exceptional case called Salomon v. Salomon & Co. Ltd. It set the birth of corporate personality meaning that a corporation is distinct from its members. The whole case is centered on Mr Aron Salomon who was involved in leather boots and shoes selling business as a sole trader. In the same year of the year 1892 he felt that it was right for him to incorporate his business and make it form a limited company under the Companies ACT of the year 1862.
The new company was known as A. Salomon & Co. Ltd and was formed by Mr. Salomon who took controlling share, 20,001 shares and other 6 shares each to the members of his family. The business was purchased from Mr. Salomon for £39,000 pounds where £10,000 was in the form of debentures, £20,000 in shares and the rest in cash.
The company was somehow poorly managed and within some time the company suffered a lot financially and ended up being liquidated. The liquidator alleges that the company was a mere alter ego of Mr. Salomon whose affairs are the affairs of a sole trader therefore the company is liable for Mr. Salomon’s debts. The argument was brought from the fact that Mr. Salomon took advantage of the structure of the corporation to reap gains.
3. Issues:
The main legal issues that arose in the case were:The main legal issues that arose in the case were:
1. Whether a new legal person was created in the form of A. Salomon & Co. Ltd. , other than the new legal person which was Mr. Salomon the majority stake holder.
2. Finally, how far the law supports the view that Mr. Salomon, the majority shareholder and debomtue holder should be made personally liable for the company’s debts.
3. In case the company was being an agent or trustee for Mr. Salomon, whether he should be liable for the debts accumulated by the company.
4. Arguments:
Plaintiff’s/Petitioner’s Arguments:
The liquidator claimed to act for the creditors in person and on this ground contended that A. Salomon & Co. Ltd. was not an independent legal person at all but an alter ego of Mr. Salomon. Mr. Salomon argued that the liquidator was seeking to make him personally accountable for the company’s debts through the utilisation of the corporate veil. They pointed out that it was formed for the purpose of taking on Mr. Salomon’s business under a new name but since the families of the company have nominal shares, the company cannot have a will of its own.
The rationale of the petitioner was that nearly all the shares were owned by Mr. Salomon and he controlled the company therefore he should be legally liable for the debts of the company. He argued that the corporate veil should be pierced by putting into consideration the fact that this company acted as an agent or a nominee for its owner, Mr. Salomon and as such he should be held fully responsible for the outstanding debts.
Defendant’s/Respondent’s Arguments:
Finally, the argument that thus there existed a genuine bona fide company called A. Salomon & Co limited in which Mr. Salomon had an interest but which was an independent company formed with the law, and should have independent from him legal personality was relied upon in defense. Mr. Salomon counsel’s defended that the Company’s incorporation under the Companies Act 1862 had complied all the formality which include the minimum of seven members. Hence, Mr. Salomon had actually found it necessary to carry out trading from behind the ‘veil’ of the company because apart from the company’s registured capital the other assets of the company were not his responsibility.
For instance, the defense also stressed that it was not unlawful for the Mr. Salomon to issue debentures to himself and thus became a secured creditor of the company. It held a favourable position for Mr. Salomon because it was a secured creditor which meant it had rights over assets of the company in case of its liquidation. As a result, Mr. Salomon was right, and he had the right to receive the money from the remaining of the company’s resources before other undesirable and unsecured creditors.
5. Judgment:
The case was first heard by the Court of Appeal where they declined the case of Mr. Salomon. The court stated that the company was a nominal or a merely an “alias” for Mr. Salomon and therefore he was held legally responsible for all the debts. But this case was later taken to the House of Lords as an appeal.
The last judgment was given by the House of Lords which overturned the decision from the Court of Appeal and the case was in favor of Mr. Salomon. The House of Lords also focused on the fact that A. Salomon & Co. Ltd. had a personality under the Companies Act 1862 and therefore the said company was distinct from the shareholders. Hence, none of the company’s debts and obligations could be claimed personally from Mr. Salomon, the holder of the company’s stocks. The Lords restated the well-established grounds of legal personality, adopted by the UK rule of law, which states that a company is a natural legal individual as soon as it has been legally established.
The House of Lords also stated that having more than fifty percent of the shares with the company also did not make the company’s legal identity to be invalid in the eyes of the law. The Lords opined that shareholders be it a single share or many cannot be taken to task for the debts of the company, and their liability is limited to the amount they invested in the company. Besides, they also discovered that Mr. Salomon’s debenture placed him as a secured creditor in the company’s management meaning that he superseded other creditors in the company.
6. Ratio Decidendi:
The main legal maxim that came out of the case of Salomon v Salomon is that once formed a company has a legal entity of its own and distinct from the shareholders. The principle is referred to as the doctrine of corporate personality which is at the core of any present day company law. According to this doctrine, the company is given the legal personality where it is endowed with the rights, duties and liabilities different from that of its members. As a result shareholders have limited liability to the company and are not required to contribute their personal wealth towards the discharge of the company’s liabilities.
The case also affirmed the position of the Law that the corporate veil cannot be disregarded simply because an individual controls more than fifty or all the shares. There is complete integrity of the legal entity so long as incorporation process has complied with the provided legislation.
Another very important principle developed in the case is principle that if a shareholder is also a creditor, like Mr. Salomon, he or she has a right to realize a secured claim for debts without losing a share in the company.
7. Obiter Dicta :
Although the House of Lords’ decision in Salomon v. Salomon was mainly centered on the Issue of separate personality, Lord Halsbury LC and other Lords use some observations concerning the potential misuse of limited liability and the corporate veil. They also admitted other problems associated with the so-called corporate form, which allowed the corporations to avoid personal responsibility and accountability. But, they pointed that if the formation was in accordance with the law, the court did not work towards probing into the formation of incorporation of the company.
8. Legal Precedents Cited:
Re Baglan Hall Colliery Co. (1870) 5 Ch App 346: This case was cited in as far as the distinction between the shareholders of the company and the organization’s legal personality was concerned.
Broderip v. Salomon [1895] 2 Ch 323: This case is the earlier case of Court of Appeal that was later reversed on House of Lords.
Ashbury Railway Carriage and Iron Co Ltd v. Riche (1875) LR 7 HL 653: This case set the legal proposition that a company cannot venture beyond the objects recited in its memorandum of association while this fundamental principle did not directly assail the existence of a corporation as a legal entity.
9. Conclusion:
Salomon v. A. Salomon & Co. Ltd: decision changed the direction of the company law. It introduced the doctrine of ‘veil of incorporation’ that separates the company and its shareholders. This case also ensured that when a company has been incorporated it conducts the business legally whereby it can own property, enter into a contract or be taken to court in its own name and all this without any reference to its shareholders.
The ruling acted in favor of limited liability and helped corporations develop by shielding the shareholders from the legal responsibility for the company’s debts. Forcing them into the hands of shareholders, while the unsecured creditors lost their rights, a move that created criticism on the fact that it allowed shareholders to take advantange of limited liability clause in a manner that would be devastating to creditors.
As in my legal opinion, the decision was legal as it complied with the legal framework of the Companies Act and set a legal precedent that can be traced to what Currently guides the Corporate Law. But at the same time it focused on the necessity of changing the legislation in favor of creditor protection which was achieved with the help of insolvency laws and company regulations. The case also helped in developing the law in the extent to which corporate personality and shareholders liability was assignable.
References:
1. The case of Salomon v. A. Salomon & Co. Ltd. , [1897] AC 22 Lord of the house of Lords.
2. Lord Halsbury, H. (1897). Judgment in Salomon v. Salomon & Co. Ltd. Law Reports: Appellate Records, 22.
3. Gower, Gower L. C. B. , & Davies, P. L. (2012). Structure of the Modern Company Law. Sweet & Maxwell.
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5. Davies, P. L. (2010). Introduction to Company Law. Oxford University Press.
6. Hannigan, B. (2018). Company Law. Oxford University Press.
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8. Morse G, & Worthington S. (2012). Palmer’s Company Law: A guide on Companies Act 2006 accompanies by brief explanations of the sections. Sweet & Maxwell.
9. Mitchell, C. (1999). Lifting the Corporate Veil in the English Courts: This paper thus aims at undertaking an empirical study with a view of addressing this research question. Company Lawyer, 20(3), 70-79.
10. Keay, A. (2007). The Corporate Objective. Edward Elgar Publishing.
