In company law in common law jurisdictions, there is no other case law that is as famous as the UK House of Lords Salomon v Salomon and Co Ltd (1896) decision. The case fully established the doctrine of separate legal personality of a registered company. This means that a registered company has rights and obligations that accrue from its separate legal personality, and not as a result of its association with the people who have subscribed to its memorandum i.e. the shareholders. The doctrine was recognized and applied in both the UK and the rest of the common law jurisdictions, but courts restricted it in other subsequent cases. This essay seeks to disagree with the statement that Salomon's case shows that incorporation, separate legal personality, and limited liability are available for all" because, in subsequent years, courts restricted the rule in Salomon v Salomon in the interests of justice.
Salomon v Salomon and Co Ltd (1896)
Mr. Salomon was a boots merchant who owned a boot making business. In fact, his initial business was a sole trader. However, he set up a company where the other shareholders were represented by his family members. Mr. Salomon owned 20,001 shares of the company, while his wife and children held the remaining six shares. Thus, the company had the number of shareholders equal to 7 that was later required by the company law. Later, Salomon sold his shoe business, which was significantly overvalued, to the company for 39,000 pounds with the consent of other shareholders. Salomon received 10,000 pounds in cash and 20,000 pounds in the form of shares worth a pound each. The company issued Salomon a debenture for the remaining 9,000 pounds.
After the sale of the business, the company faced with financial difficulties because the government was the primary customer of the company. Salomon sold part of his debenture to Mr. Benedickt in order to try to mitigate the financial difficulties the company was undergoing. However, the company went bankrupt eventually. When a liquidator was appointed to realize the assets of the company, the amount of total assets equaled only to 6,000 pounds that were used to pay a secured creditor. The court decided that the company and the creditors had a right to indemnity from Salomon as just Salomon and his family members represented the company's shareholders.
Mr. Salomon appealed to the Court of Appeal. The Court of Appeal agreed with the High Court on the grounds that Mr. Salomon violated the privileges of the limited liability and incorporation. As stated by the court, these privileges were created for independent bona fide shareholders, who make decisions about the company and are not manipulated by the dominant shareholder.
Mr. Salomon appealed to the House of Lords. At first, the House of Lord reached the same verdict as the Court of Appeal.. However, the House of Lords reconsidered the Salomon case after some facts came into light. So, the House of Lords refuted the verdict of the lower courts. Firstly, the House of Lords rejected the arguments of agency and fraud, which affected the decisions of the Court of Appeal and the High Court significantly. Secondly, the court stated that no clause in the Companies Act required other shareholders be independent of the majority shareholder. One of the judges in the House of Lords, Lord McNaghten, asserted that there was nothing wrong with Mr. Salomon taking advantage of the Companies Act to trade with unlimited liability. Although, it was apparent to the court that Salomon dominated all the other shareholders.
Accordingly, Mr. Salomon and Salomon and Co Ltd were two separate entities in law, having distinct legal rights and obligations. Thus, Mr. Salomon did not own Salomon and Co Ltd by law. The creditors signed a contract with the company Salomon and Co Ltd and not Mr. Salomon, thus, they could not recover any losses from Mr. Salomon.
The Effect of Salomon v Salomon on Company Law and Subsequent Cases: Incorporation, Separate Legal Personality and Limited Liability in Subsequent Cases
The decision in Salomon v Salomon had a profound effect on company law. According to the decision of the court, after the company is registered (after incorporation), the company is considered to be a separate entity from those people who represent shareholders. Such a decision was an unyielding rock for many years with the courts reaffirming it in several subsequent cases (Mayson, French & Ryan 2012, p. 127). According to the House of Lords, the people, who formed the company, did not matter in the incorporation of the company as long as they followed all the formal requirements stated in the Companies Act.
The doctrine of separate legal personality was considered by the court in Lee V Lee's Air Farming Ltd (1961) in affirmation of the decision in Salomon v Salomon. In this case, the court affirmed that the company could employ any of the shareholders as the company was separate from its shareholders. The court's decision in Macaura v Northern Assurance Company Ltd (1925) also affirmed the decision in Salomon v Salomon. The House of Lords decided that the insurance firm was not liable for the loss the company experienced because the insurance contract was signed between the insurance firm and the director of the company not the Company and the insurance firm. Since the company is separate from the shareholders, the contract between the shareholder and an insurance company could not cover the assets of the company, even if the contract contained such a requirement. The contribution of this case is the fact that a company could own property and the shareholders could not have right for the property of the company. An Australian case, Re Noel Tedman Holdings Pty (1976) further affirmed the decision of Salomon v Salomon. In this case, the court stated that a company could survive the death of all the shareholders. The affirmation of perpetual life supported the legal separation of shareholders and the company. In Tate Access Floors Inc. v Boswell (1991), the court further affirmed that the corporation is legally not the same person as the shareholder. The court stated that controlling shareholders should not insist on the separate identity of the company when it suits them and vice versa.
To sum the cases up, the effect of incorporation is the fact that it prevents creditors from recovering losses from the personal property of the shareholders in cases when a company incurs debt (limited liability). This applies to all the types of shareholders, both corporate and individuals. Consequently, even in cases when a company belongs to a conglomeration, the Petrin (2013, p.603) asserts that the parent company is not liable for the debts of the subsidiary and vice versa.
However, in spite of the consistency in the decisions of the courts that affirmed the decision in Salomon v Salomon, many academics questioned the fact if the House of Lords will make the same decision at present time (Macey & Mitts 2014, p. 99). Critiques have noted that the law established by the case has many exceptions that weakened its power (Cheng 2011, p. 330). Recently the courts have realized that the strict application of the precedent as set in Salomon v Salomon would lead to injustice (Small, Smidt & Joseph 2015, p. 24). Consequently, the courts decided that it would be just to disregard the decision in the Salomon v Salomon. Thus, the courts developed a new doctrine that seeks to restrict the precedent in Salomon v Salomon known as piercing the veil of incorporation (Cheng 2011, p. 329). Using this doctrine, the courts restricted the corporate personality and, especially, the aspect of limited liability.
In Petrodel v Prest Resources Ltd (2013) the court explained the reason for the restriction of the doctrine of separate legal personality as the need for the courts to avoid injustice that would result from strict application of the doctrine (McLeod 2014, p.138). In fact, this occurs when the court decides that the shareholders blurred the distinction between them and the company, or engaged in acts connected to fraud, or when the company is a scam (Campbell 2015, p. 327). However, the disregard of the separate legal personality has a particular disadvantage. According to Mandaraka-Sheppard (2014, p.3), the disregard was full of inconsistencies. In the UK case of Adams v Cape Industries Plc. (1990), courts have subsequently affirmed that the disregard of incorporation should occur only in a very narrow set of circumstances.
While the company is an entity legally separate from the shareholders, the company can act only through the shareholders or other people appointed by them (Macey & Mitts 2014, p. 99). Thus, when the courts disregard the doctrine, they are piercing the veil of incorporation to see the individuals behind the actions of the company. The first instance this can be applicable is the cases when there is proof that the company is a scam that is presented by the court's decision in Woolfson v Strathclyde Regional Council (1978). In this case, the court will serve as a shield for business that it is not incorporated for, usually an illegal act (Macey & Mitts 2014, p. 99). A closely related topic to the disregard of the doctrine is fraud. There is a consensus that the proof of fraud will make the courts to disregard separate legal personality of companies as presented in both Petrodel v Prest Resources Ltd (2013) and VTB Capital v Nutritek International Corp (2013). In fact, such situation also happens in cases, when the shareholders incorporated a company in order to escape from existing obligations. An instance of such a case was the court's decision in Gilford Motor Company v Horne (1933), where the court granted an injunction to a business person, who intended to form a company, which was meant to circumvent a covenant in restrictions of trade.
Another instance, when the disregard of the doctrine could be applied, is the cases when the company acts as shareholders' agent or is the shareholder's alter ego (Mandaraka-Sheppard 2014, p.10). One can argue that in the case of Salomon v Salomon, the company was Salomon's alter ego. Usually the courts do not imply agency and, thus, it has to be expressed in accordance with the requirements determined by the court in Adams v Cape (1990). A company is considered to be shareholder's alter ego, when there is no distinction between the members of the company and the shareholder; consequently, the observance of the corporate form would result in an injustice as apparent from the ruling in Gencor v Dalby (2000).
Additionally, courts can disregard the separate legal personality in order to punish people who used a corporation as a veil to commit crimes (Campbell 2015, 278). In the UK, the Proceeds of Crime Act contains provisions that call for confiscation of property received by the company but collected by the individual in the company, usually a director or a shareholder. The court executes this provision in order to prevent individuals from benefiting from criminal proceeds as presented by the case of R v Seager (2009).
From the discussion, it is apparent that the laws about incorporation, separate legal personality, and limited liability are exercised in the majority of instances but have a lot of exceptions. It is valid that the House of Lords established he doctrine in Salomon v Salomon and Co Ltd. However, the courts restricted the doctrine of separate legal personality in subsequent cases. Thus, the courts limited the liability in the cases, where it was apparent that upholding separate corporate persons would lead to injustice. The instances, where the court restricted independent legal personality, include the following: the cases of the company being a scam or a fa?ade, the cases with fraudulent activity involved and the cases, where the company is the alter ego of the shareholder or his/her agent. Additionally, in the cases, where a director or a shareholder uses the company as a veil to commit crimes, courts can disregard separate legal personality in order to punish the person.