Salomon v. A. Salomon & Co. Ltd. (1897)[1]

Salomon v. A. Salomon & Co. Ltd. (1897)[1]
Citation: [1897] AC 22 (House of Lords)

Court: House of Lords (UK)
Bench: Lord Halsbury LC, Lord Watson, Lord Herschell, Lord Macnaghten, Lord Davey, Lord Morris
Bench Type: Appellate Bench (Full House of Lords)

Judgment Delivered On: 16 November, 1896

Parties Involved

• Appellant (Plaintiff):
  Aron Salomon, a single owner of an already upbeat leather boot and shoe manufacturing company in Whitechapel London. He had worked at the company more than 30 years and ran the business diligently but in a modest success.

• Respondent (Defendant):
  A. Salomon & Co. Ltd. was a limited liability company (filed by Mr. Salomon himself with the Companies Act in 1862) who had six other names that were listed as nominal shareholders due to legal standards, especially being related to his family.

 Facts of the Case

The facts are based on the incorporation of a business, change of ownership to a limited company and legal responsibilities, and liabilities that result thereof.

Mr. Salomon had kept a successful sole proprietorship business that dealt with leather products and boots. He made a decision to transform his business to a limited liability company under the Companies Act, 1862 to enjoy financial advantages and reduce the personal liability[2].

He also incorporated A. Salomon & Co. Ltd, by the statute requirements that required a minimum number of seven shareholders, wherein, he issued one share to his five children, one to his wife, and another 20,001 shares to himself out of total 20,007 issued shares.

Being included in the process of incorporation:

• Salomon sold to the new company the personal business he owned at a consideration of 39000 pounds.
• This consideration was to be at £10,000 in shares, and by the issue by the company to Mr. Salomon of debentures to the extent of £10,000 secured by a floating charge over the assets of the company.
• The debentures actually converted Mr. Salomon into secured creditor of the company.

It took the firm not long before it went into financial trouble and the main problem was the economic busts and exaggeration of its worth. It had to go into liquidation in one year. The liquidator that came to represent the interests of unsecured creditors disputed whether Mr. Salomon was a secured creditor of the company, and that the company was just a sham, and was created to provide him with personal liability protection.

The logic as put forth by the liquidator was that the company was just an alias or agent of Salomon himself and therefore the company had to pay its debts because the same was a debt of Salomon. The trial court together with the Court of Appeal ruled in favor of the liquidator and contained that the company was not really independent and that Mr. Salomon had misused the incorporation process.

Salomon then moved to House of Lords.

Issues Raised

The case brought in essential questions that remain to be central to the corporate law:

• Was the company, A. Salomon & Co. Ltd. legally separate and independent to Mr. Salomon?
• Is it possible that the sole individual be in control of a company but at the same time be shielded of the fact the company bears a separate legal personality?
• Did the incorporation become invalid as a result of use of family members as nominal shareholders?
• Could the status of Mr. Salomon as a secured creditor be enforced in front of unsecured creditors?
• Was there a possibility to ask the corporate veil to be pierced in the case of the suspected abuse even in the absence of the statutory powers?

Arguments of the Parties

Appellant (Mr. Salomon):

• He contended that such incorporation was in full compliances of the Companies Act, 1862.
• The firm had the needed amount of shareholders and valid registration.
• He had secured his creditor status by use of debentures thus had a right to be paid first before the unsecured creditors.
• It was not against the law that an individual or a small group of individuals might in effect run a company provided that the formal requirements of the law were complied with.

Respondents (Liquidator and Unsecured Creditors):

• They claimed that the company was a fraud and not an entity that was actually separate.
• By reserving the control to himself, Mr. Salomon rendered corporate structure ineffective; therefore, his personal liability to the corporate debts was incorrect.
• The family members were merely shareholders, this choice was a formality to have met the minimum needed by statistics without even intending to participate.

Statutory Reference:

• Companies Act, 1862 – in particular those under the following heads:
• requirements of incorporation (seven shareholders)
• shareholders’ liability
• company legal status and face

Judgment

The Court of Appeal was overturned by the House of Lords unanimously and the right of company to have a legal personality was maintained. The Majority of findings were:

• A properly incorporated company is a separate person in law and is thus a legal entity that is independent of its shareholders irrespective of who the shares are owned by.
• The law does not actually need independent interest by shareholders and distribution of control by shareholders.
• Salomon was not committing the fraud, but every contract was conducted appropriately and on legal grounds.
• As such, Mr. Salomon had a right of priority repayment as a secured creditor and the debenture of Mr. Salomon had the validity and enforceability.

Ratio Decidendi

Separate legal personality is the most basic principle of corporate law that had been ruled in the case. The stress of the judgment was in the literal interpretation of the language of the Companies Act, 1862 and it was laid down that:

When the company is legally incorporated then it has to be treated as any other independent person having rights and liabilities of its own.

Key observations:

• The lower courts were criticized by Lord Halsbury LC to inject a moral or subjective element into totally clear cases of statutory obedience. He emphasized the fact that the legal significance of the motive of incorporation did not exist.
• Lord Macnaghten in one of his most often quoted passages stated[3]:

The subscribers are at law a totally different person… and though it may be that when the corporation is incorporated the business still is what it was before… the corporation is not the agent of the subscribers or trustee of them.

• It was not against the law to ignore the corporate structure simply because such a company was dominated by a single individual. There was also no possibility of piercing the corporate veil since fraud was not established, but on the contrary, it was a deliberate act which was not found in this case.
• Doctrines like corporate personality, limited liability and protection of corporate veil have their foundation in the decision.

Conclusion

In corporate law, the Salomon case is a landmark case which has held a lot of influence in jurisdictions that have common laws. The judgment allows companies all across the globe to:

• Take advantage of the protection of the limited liability, hence encouraging entrepreneurial effort and raising external capital.
• Set-up group structures through holding and subsidiary companies and maintain legal identity of each entity.

Criticism and Evolution:

Limited liability doctrine has been under the intense examination process. In spite of the fact that it helps to protect the business enterprise against the personal debts owed to the creditors, its stringent implementation has also been criticized as facilitating corporate wrongdoings. Examples include:

• conspicuous trading which is combined with fraudulent trade activity made in the guise of the corporate personality;
• hiding of money and tax evasion; and
• mistreatments that are accorded to family-owned companies.

To prevent these frauds the later judicial power has given rise to the principle of raising the corporate veil especially when the course of justice requires or when there is express statutory authority to so do[4]. In the United Kingdom and in India the courts have come to use this doctrine in very strictly circumscribed conditions.

Position in Indian Law:

Indian courts have followed the Salomon principle in the past few decades and have validated the views that the company is an independent juristic entity. The decisions given by the court on the case include Delhi Development Authority v. Skipper Construction Co. (P) Ltd., (1996) 4 SCC 622[5] and The State of UP v. Renusagar Power Co., (1988) 4 SCC 59[6] laid down the doctrine in its fullest and clear terms. This however has not deterred the Indian judiciary in showing a stronger tendency in piercing the corporate veil in cases of fraud, tax evasion or minority shareholders oppression.

Critical Reflection

Salomon case is a famous example of the judicial restraint and adherence to the legislation. Its stark boundary between legal and commercial realities has received accolade in the sense that it maintains corporate personality, but critics say that it is too extreme in the sense that it protects shareholders against corporate wrongdoings.

Nowadays the times are changing. It is possible to say that more moderate attitude – an attitude that does not deny the personality of the corporations, yet does not allow this personality to be abused, is gaining a currency particularly in the context of regulation, insolvency and fraud cases.

[1] Salomon v. A. Salomon & Co. Ltd., [1897] A.C. 22 (H.L.) (U.K.).

[2] Companies Act, 1862, 25 & 26 Vict. c. 89, § 6 (U.K.).

[3] Salomon, [1897] A.C. at 53 (per Macnaghten, L.J.) (U.K.).

[4] Gilford Motor Co. Ltd. v. Horne, [1933] Ch. 935 (C.A.) (U.K.); Jones v. Lipman, [1962] 1 W.L.R. 832 (Ch.) (U.K.).

[5] Delhi Dev. Auth. v. Skipper Constr. Co. (P) Ltd., (1996) 4 S.C.C. 622 (India).

[6] State of U.P. v. Renusagar Power Co., (1988) 4 S.C.C. 59 (India).