December 2, 2020

Case Brief: Salomon v Salomon

Citation [1896] UKHL 1

Court: House of Lords England

Coram: Lord Halsbury L.C., Lord Watson., Lord Herschell., Lord Macnaghten., Lord Morris., Lord Davey

Theme- Company is a separate legal entity

Subject: Companies Act, 1862 (England)

Judgement- England (House of Lords)

CONCEPT

A fundamental principle of Company law is that a Company registered under the act is an artificial legal entity, separate and distinct from the members of which it is composed. This principle was endorsed in unequivocal terms by the House of Lords in this case. Therefore, it has been established that a company has a separate legal personality. However, this principle gives leverage to corporate groups from escaping their liability.

FACTS

Aron Salomon, the Appellant, was carrying on the business of boot manufacturing as a sole trader. With the sole intent of transferring his business to a joint-stock company, (supposed to consist of his family as shareholders). There was a preliminary agreement settling the condition that part payment was to be made in the form of debentures of the company. A Memorandum of Understanding (MoU) was executed on July 28, 1892, between the Appellant, his wife and his five children as shareholders holding a single share each, and the appellant holding 20,001 shares under his name. After the effect of the MoU, ‘Aron Salomon and Company, Limited’ was established. Edmund Broderip, one of the secured creditors was issued fresh debentures to secure the repayment of his loan with 8% interest. The default is made on the part of the repayment of the interest, Mr. Broderip instituted an action for liquidation of the company. A liquidator was appointed through the order of liquidation at the instance of unsecured creditors of the company. After the payment was made to Mr. Broderip, Salomon claimed that he was entitled to the repayment, before the distribution of the amount to the unsecured creditors. To prevent such an alleged unjust embargo, the liquidator, representing the interests of the unsecured creditors, claimed that the company was a sham and Salomon was the agent of the company and therefore, was personally liable for its debt.

ISSUE DISCUSSED

Whether regardless of the separate legal identity of a company, a shareholder could be held responsible for its debt, over and above the capital contribution, so as to make such member personally liable for the company’s debt or not.

DECISIONS OF LOWER COURTS

The court of Appeal (Lindley, Lopes and Kay L.JJ.) concurred with the opinion of the High court (Vaughan Williams J.) and opined that Mr. Broderip’s claim was valid on grounds that the appellant had misused the privileges of incorporation (of the company). The Court further added that the shareholders were mere dummies of the company and the only acting agent of the company was Mr. Salomon. Therefore, Mr. Salomon (the principal) had to indemnify the company.

CONTENTIONS OF THE APPELLANT

  1. The Appellants contended that the creditors had the freedom of finding out their portion of shares and the holder of such proportions.
  2. Under Sections 6,8,30,43 or any other section of the Companies Act, 1862 there has been no objection made for a company formed for such objectives.
  3. Since the company fulfils all the legislative criteria for its treatment as a real company, it has to be treated as a separate legal entity, consisting of certain corporators but a distinct and independent corporation.
  4. The subordinate courts have created a conundrum by treating Salomon and Co. either as substantial or unreal. The courts have to choose one among both.
  5. Because there is no imposition of personal liability of a shareholder towards a company’s debt, the courts cannot go against the legislature and impose such liability on them.

CONTENTIONS OF THE DEFENDANT

  1. The major contentions of the defendants were based on factual circumstances but not on the legality of the same.
  2. The Appellant incorporated the company without an independent board of directors; he was the principal of the company and ran the company according to his whims and fancies.
  3. The Appellant took debentures and concealed the fact from the creditors to get an unjust advantage over them.
  4. Although the company was incorporated according to the Act, it never had an independent existence; the other directors (his sons and his wife) and the company were always under the control of the appellant.
  5. Due to his vast preponderance of shares, the appellant became the sole master of the company, enabling him to take any decision whatsoever.

RATIO DECIDENDI

The House of Lords unanimously overturned the judgment of the Court of Appeal and rejected the arguments of fraud and agency. To establish whether there was a fraud, the sole determination can be done by finding out whether a company was incorporated according to the act. In the present case, the company was constituted as per the act and therefore, the argument of fraud does not stand. And the company stands as a separate legal entity. It opined that it was unacceptable for the jury to interpret the statute limitations based on their personal opinion. The company ideally remained the same even though it was incorporated by the same hands that received the profits, this does not make the company a trustee or an agent of its subscribers and therefore, they are not personally liable for its debt.

The House of Lords further added that “the motives of those who took part in the promotion of the company are absolutely irrelevant in discussing what those rights and liabilities are”[1] and the legal fiction of a “Corporate Veil” between the company and its owners and controllers was created firmly. This decision also highlights the principle of “Separate Legal Personality” as a “Double-edged sword[2]. In conclusion, the House of Lords summed up by stating that, “There is nothing in the Act requiring that the subscribers to the memorandum should be independent or unconnected, or that they or anyone of them should take a substantial interest in the undertaking, or that they should have a mind and will of their own, as one of the learned Lords Justices seems to think, or that there should be anything like a balance of power in the constitution of the company.”[3]

REFERRED CASES

  1. In Erlanger v. New Sombrero Phosphate Co[4], it was held that the persons who create a company and then sell their property to that company, hold a fictional position in that company and therefore, must always be faithful and disclose any transaction that affects the capital of the company.
  2. In the case of In Re Baglan Hall Colliery Co[5], the decision of Malins V. was overturned stating that a country which has sanctioned such a law, where the liability falls on the owner, then such country is in a very deplorable state.
  3. In North-West Transportation Co. v. Beatty[6], it was decided that when a company contracts with the owner of a bulk of its shares, such a contract still stands valid and binding.

PRESENT STATUS

The decision of Salomon v Salomon has failed to pass the test of time and now is contradicted by various judgments. The recent cases like Tokyo v Karoon[7] have rejected the already set Salomon approach.

Further, in the case of VTB Capital Plc v Nutritek International Corporation[8], the courts confirmed the restricted scope of veil piercing only as a limited equitable remedy.

In a recent decision of Prest v Petrodel[9], Sumption J. confined the lifting of the veil to only two circumstances, the “concealment principle” and the “evasion principle”. Therefore, this case removed its focus from the factual corporate veil and reinstated the Salomon Principle.

CONCLUSION

The decision of Salomon v Salomon has established the principle of “Separate Legal Personality” (of a company) which allows its stakeholders to escape from personal liability in case of a crisis. However, there have been instances of rulings contrary to this principle. Nevertheless, it is a task for the academicians and legal personnel to justify the lifting of the corporate veil by the court.


[1] Gas Lighting Improvement Co. Ltd. v Commissioners of Inland Revenue, 1923 A.C. 723.

[2] PUIG G.V.,A Two-Edged Sword: Salomon And The Separate Legal Entity Doctrine, Corporation law Vol.7(3).(2000).

[3] Salomon v Salomon, [1896] UKHL 1 (Lord Macnaghten) (appeal taken from the Court of Appeal) (UK).

[4] Erlanger v. New Sombrero Phosphate Co, (1878) 3 App. Cas. 1218, 1236, 1238.

[5] In Re Baglan Hall Colliery Co, L. R. 5 Ch. 346.

[6] North-West Transportation Co. v. Beatty, (1887) 12 App. Cas. 589.

[7] Tokyo v Karoon, 1987 A.C. 45, 64.

[8] VTB Capital Plc v Nutritek International Corporation, 2013 UKSC 5.

[9] Prest v Petrodel, 2013 UKSC 34.

Contributed by: Priyanka Chemudupati and Swetalana Rout (Students, Damodaram Sanjivayya National Law University, Visakhapatnam)

The views of the author are personal only. (if any)

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