Authored By: Tripti pal
Asian Law College
CASE TITLE & CITATION:
SALMON V. SALMON & Co. Ltd.
[1897] AC 22, [1896] UKHL 1
COURT NAME & BENCH:
House of Lords England
Lord Halsbury (Lord Chancellor), Lord Watson, Lord Herschell, Lord Macnaughton, Lord Morris, Lord Davey.
DATE OF JUDGMENT:
November 16, 1896
PARTIES INVOLVED:
The case involves Aron Saloman, who ran a leather business and eventually incorporated it into a limited company called Salomon & Co. Ltd. However, the company faced financial troubles, leading to its liquidation. A liquidator sought to hold Saloman personally liable for the company’s debts.
FACTS OF THE CASE:
Mr. Salomon operated a leather business focused on boot making. Initially, he managed it as a sole proprietorship. In 1892, he established the corporation “Salomon & Co. Ltd.” He included himself, his wife, and his five children in the corporation. The family members acquired shares for Mr. Salomon because English company law at the time required a minimum of seven shareholders for a company. Mr. Salomon intended to comply with the Companies Act, 1862, as a businessman. He aimed to limit his liability and prioritize debenture holders over other unsecured creditors by transferring his trade to a limited corporation made up of himself and six family members. The newly formed company took over the sole leather business, valued at €39,000, showcasing Mr. Salomon’s success.
The company financed €10,000 for the debentures, providing a claim over all corporate assets. It issued €20,000 worth of shares at €1 each, with the remaining €9,000 paid to Salomon in cash. Mr. Salomon received €20,001 worth of shares, while his family members received the remaining six shares. Thus, he became a second creditor due to his debenture holding.
As a result, his personal liability for business debts shifted from unlimited to limited. Mr. Salomon was no longer personally responsible because he was also a managing director of the corporation. If the company failed, he would not be liable for its debts. Moreover, any leftover assets could be claimed by him to satisfy the company’s debt to him. Unfortunately, the leather business struggled, and less than a year later, Mr. Salomon had to sell his debenture to keep the trade afloat. Upon liquidation, the asset values were determined to be €6,000 for liabilities, €10,000 for debentures, and €7,000 for unsecured creditors. Therefore, after paying the debenture holders, no funds remained for unsecured debts. The company ultimately failed and entered insolvent liquidation. The liquidator, representing unsecured creditors, argued that the corporation was merely an “alias” or agent of Mr. Salomon, thus making him personally responsible for the corporation’s debts.
ISSUES RAISED:
- Was Salomon & Co. Ltd. a legally incorporated company?
- Was Mr. Salomon personally responsible for the debts of the corporation?
ARGUMENTS OF THE PARTIES:
FROM THE APPELLANT SIDE
- The solicitor representing Mr. Salomon argued that he was not personally liable for the corporation’s debts because the company was a separate legal entity from its members, as stated in the Companies Act, 1862.
- The solicitor further asserted that the rule of limited liability applied to shareholders, meaning Mr. Salomon was only responsible for the amount of his shares. 3. The solicitor also contended that Mr. Salomon was not liable simply because he held a majority of shares in the company. The honorable Lords were asked to dismiss the erroneous claims made by the respondents in lower courts.
FROM THE RESPONDENTS SIDE
- The solicitor for the respondents argued that Mr. Salomon used the company to evade personal responsibility for the corporation’s debts. Therefore, he should be liable for the debts incurred by the corporation.
- The solicitor claimed that the appellant controlled a majority of shares in the company and set it up to avoid risk. The respondent asserted that the appellant intentionally created the company to mislead his unsecured creditors.
- The respondent’s solicitor contended that Mr. Salomon did not intend to form the company to benefit its members but rather to avoid paying debts.
- The respondent’s solicitor argued that the company was a fraudulent and deceptive entity that exploited its creditors.
RELATED PROVISIONS:
The Companies Act, 1862
Section 6 – Mode of forming company – Any seven or more persons associated for any lawful purpose may, by subscribing their names to a memorandum of association and complying with the requirements of this Act regarding registration, form an incorporated company, with or without limited liability.
Section 8 – Memorandum of association of a company limited by shares – When a company is formed with limited liability for its members based on unpaid shares, the Memorandum of Association must contain the following: the company’s objectives for establishing its purpose.
Section 30 – No entry of trusts on register – No notice of any trust, expressed, implied, or constructive, shall be entered on the register or be received by the registrar concerning companies under this Act registered in England or Ireland.
JUDGMENT:
After careful consideration, the House of Lords rejected the allegations from the opposing party. They upheld the appellant’s argument that the company was a distinct legal entity separate from its members and shareholders, with a slight majority of 3 to 2. The House of Lords strongly reinforced the doctrine of legal personality stated in the Companies Act, 1862, ruling that creditors of an insolvent corporation could not demand that the company’s shareholders cover their debts. The Lords emphasized that a company recognized under the Companies Act is a separate entity, not an agent of its owner or controller. They also noted that using debentures instead of shares can help investors manage risk.
The House of Lords, on appeal, overturned the Court of Appeal’s decision, agreeing that the corporation was a distinct and independent entity. The Lords acknowledged that Mr. Salomon approached the formation of the company correctly. He had legally incorporated the business because the Companies Act only required seven members, each holding at least one share. The Court affirmed that shareholders are protected by the limited liability doctrine and cannot be held personally liable for the firm’s debts beyond the value of their shares. Thus, the case of Jennings v. Crown Prosecution Service established a clear corporate veil between the company and its owners or controllers as defined by the Salomon case.
In the words of Lord Halsbury,
Either the limited company was a legal entity or it was not. If it was, the business belonged to it and not to Mr. Salomon. If it was not, there was no entity and nothing to act as an agent, making it impossible to claim both existence and non-existence of a company.
In the words of Lord Herschell,
He pointed out issues with the Court of Appeal’s logic. Many companies had been created where shareholders had no real interest in the company. Anyone dealing with such a company was aware of its nature and could understand the distribution of share ownership through the shareholder records.
In the words of Lord Macnaughten,
He questioned what was wrong with the appellant benefiting from the company’s provisions that the Act allowed. The judges should not restrict what the Act allows, so if local laws permitted certain actions, those actions should not face severe criticism. In Macaura v. Northern Assurance Co., it was ruled that a company’s property belongs to it and not to its individual members, meaning that even if the majority shareholder has no absolute interest in the corporation’s assets, they do not own them.
RATIO DECIDENDI:
The central legal principle from Salomon v. Salomon, established by the House of Lords, states that a corporation is a distinct legal entity, separate from its shareholders, even when it operates as a sole proprietorship. This principle dictates that shareholders’ liabilities are limited to their unpaid shares, freeing them from personal responsibility for company debts. Lord Halsbury’s ruling emphasized the importance of maintaining the corporate veil and protecting a corporation’s independent legal identity. This judgment set the foundation for the concept of limited liability, a crucial aspect of corporate law. The decision has significantly shaped corporate structures and commercial practices, influencing the legal landscape for generations.
In essence, the ruling in Salomon v. Salomon reaffirms that a corporation has an independent legal existence, shielding its shareholders from personal obligations while also protecting the corporation’s interests.
CONCLUSION:
The landmark case Salomon v. Salomon & Co. Ltd. established the important principles of the separate legal entity and limited liability of corporations. These principles have significant implications for corporate governance, minority shareholder protection, and preventing fraud. Once a corporation complies with the Companies Act, it will be properly formed. The idea of lifting the corporate veil emerged after the influential decision in Salomon’s case, as no individual can hide behind the company’s distinct entity to commit fraud and avoid responsibility. In this instance, no wrongdoing was committed by the appellant, who was legally the sole creditor of the firm and had the right to payment ahead of unsecured creditors since Mr. Salomon’s claim was linked to the company’s assets.
This case has significantly shaped the administration of modern company law and has served as a precedent in many global cases. Ultimately, this famous case has provided essential protections for shareholders and creditors while promoting avenues for investment growth. Future considerations regarding the corporate veil can be assessed based on factors related to a company’s management and governance.
REFERENCE(S):
- Salomon v. A. Salomon & Co. Ltd., [1897] A.C. 22 (H.L.) (appeal taken from Eng.). • Companies Act, 1862, 25 & 26 Vict. c. 89 (UK).
- Jennings v. Crown Prosecution Service, [2008] UKHL 29, [2008] 1 A.C. 1046 (appeal taken from Eng.).
- Macaura v. Northern Assurance Co. Ltd., [1925] A.C. 619 (H.L.) (appeal taken from Eng.).
