Salomon V a Salomon

Salomon v A Salomon and Co Ltd (Salomon) has created an impressive case in English Law history. The decision of the House of Lords in Salomon has reaffirmed the separate legal personality of a company. A separate legal personality is also known as the corporate personality. It is one of the consequences of the Company Act 2006 which incorporated a sole trader company to a limited company. When a company has undergone incorporation, it simply means that the shareholders of the company are separated from the company. Therefore, the shareholders have limited liability. In an incorporated company, shareholders get a benefit of having limited liability. The assets of the company do not belong to its members and the company can only sue or be sued under its own name only. On the other hand, there are particular circumstances whereby the court is trying to abstain the principle of separate legal personality and limited liability to pinpoint the fact behind incorporation – it is called “the lifting or corporate veil”.

From my point of view, I strongly agree with the decision made by Lord Macnaghten in House of Lords in the Salomon case because he alleged a true and fair view on the case. Mr Salomon had successfully appealed to the House of Lords and Mr Salomon managed to acquire his rights, which is to obtain a separate legal personality; he was only liable to the amount of company debts on the shares that he owned. In this essay, the doctrine and incorporation of the case of Salamon v A Salomon and Co Ltd and the lifting of corporate veil is critically discussed.

A promoter is a person who knows of the idea on how to incorporate a company and carries on with the procedures and registration to convert a sole proprietorship company to a limited company. Cockburn J. in Twycross v. Grant has enounced that a promoter is defined as a person who undertakes all the procedures of a project to achieve the objective of the project. In Salomon v A Salomon Co Ltd (Salomon), Mr Salomon seemed to be the promoter of his own company. However, when the company runs into liquidation, the High Court and Court of Appeal decided against Mr Salomon, and said that he should be treated as if the company was his agent or trustee. The main intention of Mr Salomon incorporating the company to a limited company was because the family wanted to be part of the company. According to the Companies Act 1862, in order to register as a limited company, a company needs at least 7 shareholders.

Mr Salomon has allotted each £1 share for his 5 children and his wife; he himself was holding 20,000 £1 shares. It is hard to argue that Mr Salomon formed the company intending to defraud the company creditors because Mr Salomon had already gone through all the necessary procedures to incorporate the company. Smith v Hancock demonstrated a situation whereby a covenant was not broken despite some violations in the agreement. Lindley LJ mentioned that a promise is said to be broken if the purpose of setting up the company was to be a “mere cloak”. Relating this situation to the discussed Salomon case above, the Salomon case showed a genuine intention of forming the company even though that does not totally determine if relief should be granted to the creditors. Therefore, in determining corporate responsibility, the motives of setting up a company is less significant.

Doctrine of Incorporation
(i) Separate Legal Personality

In Salomon, Lord Magnaghten emphasized that once a company is incorporated, the company’s doings are thus being conducted by a separate person from the company. According to the provisions of the Companies Act 2006, a separate legal personality is an elementary characteristic in a company. When a company has been incorporated, it’s members are separated from the company, which means that when a sole trader incorporates his company, the assets of the company will not belong to the members anymore as an incorporate company owns its own assets. Furthermore, shareholders of the company have limited liability, and hence they are liable on the debts of the amount they have invested in the company and the company will be liable for its own debts. Separate legal personality and limited liability are known as the most important aspects in an incorporation company. Macaura v Nothern Assurance Co (Macaura) is one of the best examples to support the case of Salomon. Mr Macaura sold the timber to the company in returned issued capital assets, which belongs to the company, and not himself. In result, he was not able to claim the insurance for the timber that was covered by the insurance under his own name because the assets did not belong to him anymore. Additionally, in Macaura, it clearly illustrated that shareholders personal assets were a
partition from the company.

Apart from that, a separate legal personality means that a company has legal right, which is separated from its members, and a company can only sue and be sued under its own name. The company members have no right to claim any benefits by utilizing the company’s title. A company reserves the rights to enter into legal relationships and employment contracts with the members of the company. In Salomon, both of Mr Salomon’s sons were the directors for Salomon and Co Ltd. Lee v Lees Air Farming Ltd showed a well illustration of Salomon; Lee was a major shareholder and was also the director for the company. Furthermore, a company enjoys perpetual succession. Company members come and go easily but a company will stay in perpetuity upon death of the members or even bankruptcy. Only by legal actions such as winding up and going into liquidation can bring a company to an end.

The most attractive principle in a separate legal personality is the limited liability. If a company is experiencing insolvency, the shareholders of the company are only liable for the amount they have invested in the company. In Salomon, the liquidator went against Mr Salomon because Mr Salomon was the major shareholder of the company and has the obligation to recover the value of debenture and was hence liable for the company debts. According to Lord Magnaghten, Mr Salomon did actually put effort to recover the value of debenture for its company; and as a result the motive of Mr Salomon’s incorporation the company wasn’t relevant to the corporate liability. Therefore, Mr Salomon was a subscriber and also a promoter to the company.

In my opinion, I feel he should not be liable for the company’s liabilities. The House of Lord stated that since Mr Salomon ran the company as a “one-man business”, Mr Salomon owned the rights of limited liability. Thus the debt belongs to the legal entity of the company, and not him. In contrast, for an unlimited liability company, shareholders are liable for a company’s debt only when the company’s liability has been taken away without an apparent reason. In fact, a limited liability is just a logical effect to a separate legal personality. Nevertheless, creditors’ claims cannot be strongly against the shareholder’s assets as their claims are restricted to the company’s assets only. This is due to the absence of legal relationship between shares and a company’s property. It is worth noting that limited liability is only beneficial to the shareholders of a company.

The Lifting of Corporate Veil

Under certain circumstances, some people intend to incorporate the company to abuse or prevent the effect of separate legal personality, which is the veil of incorporation in order to evade from their obligations and wrongdoings. In other words, sometimes people may incorporate a company to defraud the company’s liability. If the judge rigorously applied separate legal personality, the deceiver will then be not charge for his action. To seek the truth and fact behind the incorporation, sometimes the court will disregard the veil of incorporation. This action is known as ‘lifting the veil of corporation’ or in other words ‘piercing the corporate veil’. Apparently in Salomon, there wasn’t any situation showing that the subscriber, Mr Salomon, of the company was personally liable for the company’s debt or trying to defraud from its own company. Mr Salomon incorporated the company with sincerity of intention ant not forming a sham company nor trying to abuse the privilege of separate legal personality.

Ord v. Belhaven Pubs has well-illustrated the Salomon case as well, where Mr and Mrs Ord reorganized Belhaven Pubs so it that has no further assets left in the company. They then requested to Ascott Holding Ltds to substitute Belhaven Pubs for money. The court held that the new company of Mr and Mrs Ord have not been a façade for wrongdoing or trying to evade from any legal obligations so it was held as a ‘fraud exception’ from this case.

To seek the truth behind the incorporation, sometimes the court needs to ignore the consequences of incorporation, which is the separate legal personality. There is a limitation of judicial intervention and therefore only under some circumstances, a court will exercise its purpose to pierce the veil of incorporation. Lord Hanworth Mr stated in Gilford Motor Co Ltd v Horne(Gilford) that Mr Horne formed the company by using his wife’s name as a device to evade the contractual between him and Gilford Motor Co Ltd, which was his previous employer. In Gilford, it clearly demonstrated that Mr Horne formed the company as a sham to escape the legal obligations from the former employer. Besides that, Jones v Lipman showed a similar circumstance of sham companies’ cases. Here, Mr Lipman was supposed to sell the land to Mr Jones, however Mr Lipman formed a sham company by transferring the land to the company to avoid the contractual obligations from arising between he and Mr Jones. In these cases, it showed the exceptions that a court was forced to lift up the veil of incorporation to seek the truth behind the incorporation. In Salomon, the House of Lords didn’t disregard the principle of incorporation because the main intention of Mr Salomon converting his own company to a limited company was with good faith rather than seeking for any evasion of legal obligation and creditors liability. That was why Mr Salomon was not liable for the company’s debt that exceeded the amount of the shares that he owned in the company.

Last but not least, this essay clarified the definition of separate legal personality in a limited company. As Lord Halsbury stated in the Salomon case, “Once the company is legally incorporated, it must be treated like any other independent person with rights and liabilities appropriate to it self…”. A limited company and its members of the company are entirely two different entities and they cannot be bound together. There might be an agency between the members and its company, but only when there is an agreement or contractual between the members and its company. Concisely, only the members of a company are liable for the company debts when a court has pierced the veil of incorporation and found that the company was formed as sham or noticed a wrongdoing of its company members.

In conclusion, there are only a few circumstances whereby a court will pierce the incorporation to seek the truth behind. There must a balancing act between the consequences of incorporation, which is the separate legal personality and limited liability, and also the lifting of the veil of corporation in order to reach a fair decision for the claimants and defendants.

References

1. Griffin. S (2000) Company Law: Fundamental Principles. 3rd Edition., Pearson Professional Limited 1994, 1996

2. French. D, Mayson. S and Ryan. C (2011) Company Law. 28th Edition. Oxford University Press Inc., New York.

3. “The Nature of Legal Personality”, University of London External System, [Online] [Accessed on 9th of February 2012] http://www.londoninternational.ac.uk/current_students/programme_resources/laws/subject_guides/company_law/company_law_ch3.pdf

4. Graham. T and Poole. J(2010) ‘Switching assets from one shadowy hand to another’: piercing the veil of company and trust. Trusts and Trustees, Vol. 16, no. 9, pp705-726 [Online] [Accessed on 9th of February 2012] http://moodle.mmu.ac.uk/file.php/2877/PIERCING_THE_VEIL_OF_COMPANY_AND_TRUST.full.pdf

5. “Lifting the veil of incorporation”, ”, University of London External System, [Online] [Accessed on 9th of February 2012] http://www.londoninternational.ac.uk/current_students/programme_resources/laws/subject_guides/company_law/company_law_ch4.pdf

6. “Lifting the Corporate veil: A reassessment of the fraud exception” Cambridge Law Journal (1977), pp284-290 [Online] [Accessed on 7th of February] http://moodle.mmu.ac.uk/file.php/2877/LIFTING_THE_VEIL_REASSESSING_THE_FRAUD_EXCEPTION.pdf

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[ 1 ]. [1897] AC 22
[ 2 ]. Salomon v A Salomon Ltd [1897] AC 22 (Lord Magnaghten ) at p 51 [ 3 ]. “The Nature of Legal Personality”, University of London External System, [Online] [Accessed on 9th of February 2012] [ 4 ]. [1877] 2 CPD 469 at 541

[ 5 ]. Twycross v Grant [1877]2 CPD 469 (Cockburn J. ) at 541 [ 6 ]. [1894] 2 Ch 377
[ 7 ]. [1925] AC 619
[ 8 ]. [1961] AC 12
[ 9 ]. “The Nature of Legal Personality”, University of London External System, [Online] [Accessed on 9th of February 2012] [ 10 ]. Graham. T and Poole. J(2010) ‘Switching assets from one shadowy hand to another’: piercing the veil of company and trust. Trusts and Trustees, Vol. 16, no. 9, pp705-726 [Online] [Accessed on 9th of February 2012] [ 11 ]. [1998] 2 BCLC 447

[ 12 ]. [1933] Ch 935
[ 13 ]. Gilford Motor Ltd v Horne [1933] Ch 935(Lord Hanworth MR) [ 14 ]. [1962] 1 WLR 832