Salomon v A Salomon & Co Ltd [1897] AC 22

1.  Introduction

The case Salomon v A Salomon & Co Ltd is one of the most famous judgments of corporate law, as it lays down one of the fundamental principles thereunder: separate legal personality. The common law was put under significant test through the ruling by the House of Lords when they declared that the moment a company is incorporated, it becomes an altogether different legal personality in the eyes of the law, in spite of the fact that most or even the entire shares might be held under the single ownership of a person. Then came a huge blow to the doctrine of limited liability whereby the liability of shareholders is capped at the extent of their investment in the company.^[1] This judgment not only set the pedestal for the modern company law but is even today a cornerstone principle in the principles of corporate governance and the insolvency law of the country.^[2]

2.  Details of the Case 

• Court: House of Lords
• Case Citation: [1897] AC 22 – Date of Judgment: 16 November 1896  
• Bench:
• Lord Halsbury LC
• Lord Watson
• Lord Herschell
• Lord Macnaghten
• Lord Morris
• Petitioner: Aron Salomon
• Respondent: A Salomon & Co Ltd (through the liquidator)
• Statute Involved: Companies Act 1862

3.  Facts of the Case

Aron Salomon was an experienced leather merchant and boot manufacturer based in London.

For ten years, he had been carrying out his trade as a sole trader, but he decided to incorporate

the same in the year 1892 under the Companies Act of 1862.^[3] Salomon formed a company with limited liability, A Salomon & Co Ltd. He was its major shareholding partner along with his wife and five children. Salomon held 20,001 shares, and each family member owned a single share.⁴

Salomon had the boot-making business transferred to the company by selling it for £39,000. For this, he received debentures of the value of £10,000 secured by a floating charge on the assets of the company and the remainder in shares. Salomon thus became both the principal shareholder and a secured creditor of the company.^[4]

When the company had just been incorporated, it began to face financial difficulties. It became bankrupt within a year. At the point of liquidation, the company’s assets proved to be insufficient to recover its debts. As the holder of debenture, Salomon came in front of those creditors who were not secured creditors. He filed to have his rights enforced to recover the debt levied upon him. However, the unsecured creditors attacked the argument of Salomon and insisted that the company was merely a “sham” or an “agent” of Salomon and consequently Salomon must accept liability personally for the debts of the company.

4.  Legal Issues

The salient point of law in Salomon v Salomon was whether A Salomon & Co Ltd was a distinct legal personality from Aron Salomon or whether Salomon could be compelled to pay the debts of the company by reason of his dominating control over it. The case challenged the ambit and application of the doctrine of limited liability, whereby shareholders enjoy immunity against personal liability, and if such a doctrine can be ignored when a company was really controlled by one individual.

The specific legal questions thus raised were: 

1. Whether incorporation of the company was valid on the facts that Salomon had overwhelming control over it.
2. Whether the company was a sham for the protection of Salomon from personal liability, and whether the corporate veil could be lifted to hold him liable for the debts of the company.

5.  Arguments  

Arguments of the Liquidator and Creditors: 

The liquidator and the unsecured creditors argued that A Salomon & Co Ltd was only the agent of Aron Salomon and a sham or mask and could not be regarded as possessing a separate legal personality. They argued that Salomon had resorted to the corporate form to avoid individual liability and had used it as a tool to protect himself from personal liability, while at the same time, he was managing the company in all respects.^[5] They further argued that Salomon should bear the personal liability of the debts of the company because he had constituted the company as its alter ego.

-Arguments of Aron Salomon: 

Salomon argued that a valid incorporation was made of A Salomon & Co Ltd under the Companies Act of 1862. He noted that the company is a distinct legal entity from himself, hence he cannot be held liable for the debts of the company. He then observed that he had satisfied all statutory requirements, including the minimum number of seven shareholders. The company, he also noted, was formed in accordance with the legal formalities. Therefore, by his reasoning, he could not, as a personal individual, be held liable for the obligations of the company.

 6.  Judgment 

 This case was first heard in the High Court, then appealed in the Court of Appeal, and finally concluded in the House of Lords.

• Case in High Court:

The High Court was of the opinion that the company was acting as an agent or trustee of Salomon and effectively carrying on business as a sole trader but masked by being a corporation. The court thus concluded that Salomon should not be allowed to benefit from the principle of limited liability when he is in full control of the company.

• Court of Appeal Decision:

The Court of Appeal affirmed the judgment of the High Court. Lord Justice Lindley: The company was a “mere scheme” designed to allow Salomon to carry on his business as if he were himself but to keep himself free from personal liability to pay the debts of the company. Such a provision of the Companies Act would be considered unlikely to afford protection to any person who made use of incorporation for the purpose of limiting his own liability at the very time as he retained his whole control over the company.

• House of Lords Decision:

The House of Lords, per Lord Halsbury LC, noted that once incorporated according to law, a company remains a legal entity separate from its shareholders. The law recognizes A Salomon & Co Ltd as a legal company that has rights and liabilities. Thus, the debts belonged to the company itself and not to Salomon; he was not personally liable for the same. House of Lords dismissed the contention that it was a sham or an agent of Salomon. House of Lords clarified that the company had passed all the statutory requirements for incorporation which Salomon had done.

The Lords pointed out that the fact that Salomon owned most of the shares and virtually held control over the company could not destroy the principle of the separate legal personality.^[6] Salomon could then be liable for the debts of the company only up to the quantum of his shares and debentures.⁸

7.  Principle of Laws Established

The fundamental salient principles of company law articulated by Salomon v A Salomon & Co Ltd are:

• Separate Legal Personality: On incorporation, a company acquires a separate legal existence. In other words, it acquires its own property, enters into contracts, incurs debt, and can sue or be sued in the name of the company. The shareholders are an entity apart and liable for no contractual obligations of the company.
• The limited liability shareholders are liable only up to the amount of their investment made in the company. This means they do not have personal liabilities towards the debts of the company except to the extent of the value of their shares, unless they had guaranteed the company’s obligations personally or had committed any fraud.

8.  Impact on Company Law

The ruling in Salomon v Salomon has been reckoned as one of the most important decisions in company law, which would establish the principle of separate legal personality as the cornerstone of modern corporate governance. The doctrine of limited liability since has been allowed to enable the general application of limited liability companies as vehicles of business operations, consequently allowing business entrepreneurs and investors to take on commercial risks by not exposing their personal assets to the creditors of the company.

However, the principle of separate legal personality provides substantial protection to the shareholders and courts have also evolved the doctrine of “piercing the corporate veil” to prevent abuses. There are certain exceptional conditions such as fraud or improper conduct under which courts might proceed against the shareholders for the debts of the company while

disregarding the company’s separate legal personality. That’s to say, the corporate form shall not be abused to perpetrate fraud or to avoid legal obligations, even though those cases are extraordinary and require very strong evidence.

9.  Conclusion  

Salomon v A Salomon & Co Ltd is a landmark case in corporate law that affirms the view on separate legal personality and, thus on limited liability. This ruling therefore gave entrepreneurs and investors certainty so this made limited liability companies become a main vehicle for business activity. The principles offered in this case form the fundamentals of the modern legal landscape under which corporate governance, insolvency law and the regulation of business have governed the world over, while the context of this case highlights the need for caution to be exercised when corporate structures are employed.

10.  Reference

• Salomon v A Salomon & Co Ltd [1897] AC 22
• Gower, LCB, Principles of Modern Company Law, 6th edition, Sweet & Maxwell 1997
• Davies, Paul, Gower and Davies’ Principles of Modern Company Law, 8th edition, Sweet & Maxwell 2008

[1] Salomon v A Salomon & Co Ltd [1897] AC 22.

[2] L.C.B. Gower, Principles of Modern Company Law 325 (6th ed. 1997).

[3] Ibid. ⁴ Ibid.

[4] Paul Davies, Gower and Davies’ Principles of Modern Company Law 312 (8th ed. 2008).

[5] L.C.B. Gower, Principles of Modern Company Law 325 (6th ed. 1997).

[6] L.C.B. Gower, Principles of Modern Company Law 325 (6th ed. 1997). ⁸ Salomon v A Salomon & Co Ltd [1897] AC 22.