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Is the decision in Salomon and Salomon & Co [1897] AC 22 still good law?

Is the decision in Salomon and Salomon & Co [1897] AC 22 still good law?

 

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Introduction

SLP (Separate Legal Personality) has emerged as the fundamental principle upon which company law hinges. SLP forms the basis of the existence and functioning of a company and is largely viewed as the most insightful and reliable statute of corporate jurisprudence. Distinctively, the principle of “SLP” has had to endure much agitation historically, not to mention that it is amongst the most contestable issues at law, both across and within jurisdictions. However, this basic tenet, created in the historic Solomon v Solomon case, is still widely applicable today and is deemed to form the basis of the English company law, as well as the universal commercial law administration. Since 1897, the basic tenet of the SLP of a company has been recognised as a fundamental aspect of company law. Up to this point, the company’s legal relationships mainly hinged on activities and transactions between ‘real’ and ‘natural’ persons but since then, the legal system has increasingly extended these legal relationships to encompass relations with the company. Consequently, the basic tenet of SLP of a company has brought into existence numerous theoretical and practical considerations regarding its application, as well as the associated implications. Accordingly, the aim of this essay is to examine critically whether the decision in Salomon v Salomon still constitutes good law.

Facts

Salomon operated a boot-making business as a sole proprietorship. He then transferred ownership of the business into a Limited Liability Company (LLC), with members of his family and himself as the major shareholder being incorporated as members of the company. The newly incorporated company paid the transfer price to Salomon as debentures and company shares via a floating charge of the company’s assets. Later, the business failed and the company went into liquidation. Salomon sought to recover the transfer price held in shares and debentures but his right of recovery was contrary to the claims held by the company’s unsecured creditors, who would have had no compensation had Salomon been successful in the liquidation proceedings.    To overcome such unproven exclusion, the unsecured creditors, through the liquidator argued that because the company was basically an agent of Salomon, it was thus a sham. Consequently, Salomon was personally responsible for the debt incurred by the company considering that he was the principal.

Issue

Salomon v Salomon revolved around the issue of certain unsecured creditors who were opposed to Salomon being compensated as the majority shareholder of the company through the liquidation process, on grounds that he was personally liable for the debt incurred by the company. Accordingly, the issue was if, irrespective of the fact that a company is a separate legal entity in its own right, a controlling shareholder could be held personally liable for the debt incurred by a company, barring their capital contribution to the company for purposes of exposing such a shareholder to unrestricted personal liability.

Ruling

In its ruling, the Court of Appeal argued that since Salomon’s incorporation of the company contravened the bona fide objective of the 1862 Companies Act which was active at the time, the company was hence a myth. Additionally, the Court of Appeal declared that the company that Salomon had incorporated had proceeded to undertake its business activities as an agent of Salomon. For this reason, Salomon should be held personally liable for the debt incurred by the company. However, Salomon appealed this ruling and the House of Lords overturned the ruling by the Court of Appeal. In a unanimous decision, the House of Lords argued that since the company had been duly incorporated, it ought therefore to be treated as an independent person governed by its own liabilities and rights. Furthermore, the House of Lords held that the motives of persons involved in promoting the interest of the company had no relevance in discussions regarding what constituted such liabilities and rights. In this way, the Salomon case was instrumental in creating a legal fabrication of a “corporate veil” between the controller/owners of a company and the company itself.

Implications

The Salomon case set an uncompromising legal precedent regarding the SLP, as evidenced in such subsequent cases as Macaura v Northern Assurance Co and Lee v Lee.  Therefore, any obligation, liabilities, or rights of a corporation are distinguishable from those of a company’s shareholders. In this case, the shareholders’ accountability hinges on “limited liability” or their capital contributions. The development of corporate fiction was with a view to allowing groups of individuals to pursue an economic goal collectively while overcoming possible exposure to liabilities or risks as an individual. This enables a corporation to execute contracts, own property, make investments, raise debt, and assume various obligations and rights, independent of members.  Furthermore, since corporations can be sued and sue in their own right, this also promotes legal course. Another vital implication of SLP is that even after the death of its members, a company remains an active legal entity.

The House of Lords made a good decision to overturn the ruling issued earlier by the Court of Appeal in Salomon v Salomon. Consequently, the case is now universally acknowledged as authority for the tenet that a company should be treated as a separate legal entity from its owners/controllers.

The Salomon principle has weathered many storms owing to its recognition that companies do have practical utility.  It recognises the company as a separate legal entity typified by share transferability, majority rule, perpetual existence, specialised management, limited liability, and flexible financing methods, among other attributes. Moreover, the Salomon principle aids in our understanding that a corporation is characterised by various socially and economically beneficial functions. A corporation also permits members of the public who have invested in it to share in its profit without having to manage the business. From a practical context, however, we could argue that the House of Lords did not make a good decision in Salomon v Salomon, with some critics even terming the ruling “calamitous” (35). While Salomon v Salomon formed the basis for the founding of the independent existence of a corporation, a highly significant principle in company law, (36), in case this principle is applied inflexibly, as happened in Salomon, there is the likelihood that it could help shield certain parties unreasonably, and this would end up hurting individuals dealing with companies (37).

By identifying the company as an independent person, the House of Lords in Salomon v Salomon endevoured to legitimise the application of corporate form by such private enterprises as a small partnership and individual traders which are not interested in raising capital from the public but are eager to insinuate an entity between their creditors and themselves. The House of Lords further opined that once a company has been registered in line with the existing Company Act, it becomes a new legal entity in its own right, distinct from its shareholders. This is the case even where one individual holds virtually all the shares issued by the company, or where the company has barely complied with all the legal provisions of the Act.  In its ruling, the House of Lords had consented to a change ideas regarding what the company entailed, as well as what it could achieve. The House of Lords sought to separate the individual owner of a company from the company as a legal entity and in this way, overlooked the economic reality of a one-man corporation. Goulding contends that Salomon v Salomon comes under criticism for two reasons. To begin with, the decision by the House of Lords affords even seemingly honest incorporators a favoured position in the form of the limited liability even in otherwise unnecessary circumstances. This is aimed at encouraging incorporators to commence or continue with their business or trade. Secondly, the decision affords unscrupulous promoters or private corporations the opportunity to misuse the benefits accrued from the Corporations through the inclusion of an under-capitalised company.

Salomon v Salomon also helped to establish the rule that when a corporation acts, it acts not as an agent or alias of its owners, but in its own right and name. In Gas Lighting v Inland Revenue Commissioner, Lord Sumner sought to distinguish a duly incorporated company as a legal entity, distinguishable for its shareholders or investors. In any business that such a company is involved in, capital employed and debts assumed, are those of the company itself, as opposed to those of its shareholders. Additionally, the ruling by the House of Lords in the Salomon case developed a crucial doctrine shareholders of a company under common law are exempted from any liabilities that the company may have incurred, such as debt, over and above their initial capital investment. Shareholders, therefore, bear proprietary interest in the company’s assets. Similar sentiments have been echoed by rulings made in later cases, such as the one made by Latham CJ in The King v Portus, in deciding if employees working for a Federal Government-owned company were actually employees of the Federal Government, or not. In this case, Latham CJ held that since the company is a separate legal entity from its shareholders, its shareholders should not be held accountable for the debts that the company owes creditors. This is because shareholders are governed by their limited liability to the company in terms of contribution and hence cannot claim ownership over the property of the company.

Like all other legal provisions, there are exceptions to the overarching principle of SLP in terms of application. Such exceptions include the decision by the courts to “lift the corporate veil” and reach out to the company’s insiders. Adams v Cape Industries has identified various grounds that could influence the court’s decision to pierce or life the veil, which constitutes an exception to the SLP. They include: (i) fraud; (ii) agency; (iii) group enterprise; (iv) sham or facade; (v) unfairness or injustice. The English courts have invoked these exceptions variously, in such cases as Caterpillar v Saenz, Beckett v Hall, and Akzo Nobel v The Competition Commission, to name but a few. While the development of these exceptions to the SLP in defining its boundaries has not been quite smooth, lifting the veil as a statutory exception has become quite popular.

The basic tenet formed in Salomon as it relates to single companies has since been extended to include groups of companies following the ruling issued by the Court of Appeal in Adams v Cape Industries. The passage of the 2006 Companies Act which now handles virtually all aspects of Scottish and English company law is a testament to the sweeping changes that have been ongoing in UK company law. Nonetheless, these changes did not affect the Salomon principle, so most of its implications are virtually unaffected. This is a further indication of the fundamental importance of the decision arrived at by the House of Lords in the case and its effect on company law. It is a further testament to the difficulty in conceiving of a way to either materially feature or amend the Salomon principle without running the risk of significantly altering the rationale and nature of the UK company law. Although the Salomon principle is not without its fair share of tribulations, such as in case of possible abuse of majority control or corporate veil, the legislation has proven to be quite flexible and responsive to new effective statutory mechanisms (for example, s.994 of the 2006 Companies Act) and common law precedents. Besides, the ruling of the House of Lords in Salomon v Salomon variously portrays a legal principle that is not only a necessary evil but also practical retaliation to the varied needs of commerce.

Conclusion

The ruling of the House of Lords in Salomon is still predominant today and has remained an underlying principle of English company law. While veil piercing might be invoked by such triggers as facade, sham, and fraud, among others, such grounds for the exception are not in themselves exhaustive. This gives precedence to court interpretations, which are usually done on a case-to-case basis. Despite sweeping changes in the UK company law, the courts regularly invoke the ruling of Salomon, implying that it is still a good law.

Bibliography

Books

Davis Paul and Davies Paul L, Introduction to Company Law (Oxford University Press 2010)16.

Goulding Simon, Principles of Company Law (Cavendish Publishing Limited 1996) 40.

Lowry John and Reisberg Arad, Pettet’s Company Law: Company Law and Corporate Finance, 4th edn (Pearson 2012) 37.

McLaughlin Susan, Unlocking Company Law (Routledge 2015) 19.

Case Laws

Adams v Cape Industries plc [1990] Ch 433

Akzo Nobel NV v Competition Commission [2013] CAT 13

Beckett Investment Management Group Ltd. and others vHall and others [2007] EWCA Civ 613

Caterpillar Financial Services v Saenz Corporation [2012] EWHC 2888 (Comm)

Gas Lighting Improvement Co Ltd v Inland Revenue Commissioners (1923) AC 723

King v Portus; ex parte Federated Clerks Union of Australia (1949) 79 CLR 42

Lee v Lee’s Air Farming Ltd [1960] UKPC 33

Macaura v Northern Assurance Co Ltd [1925] AC 619

Salomon v Salomon [1897] AC 22

Acts

The Companies Act 1862 (25 & 26 Vict. c.89)

Companies Act 2006 (c. 46)

[1] Paul Davies and Paul L Davies, Introduction to Company Law (Oxford University Press 2010)16

[2] Susan McLaughlin, Unlocking Company Law (Routledge 2015) 19.

[3] Salomon v Salomon [1897] AC 22

[4] Simon Goulding, Principles of Company Law (Cavendish Publishing Limited 1996) 40.

[5] Adams v Cape Industries plc [1990] Ch 433

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