Salomon vs Salomon- A case Analysis Essay

AbstractAaron Salomon was a successful leather merchant who specialized in manufacturing leather boots. For many years he ran his business as a sole trader. By 1892, his sons had become interested in taking part in the business. Salomon decided to incorporate his business as a Limited Company, Salomon & Co. Ltd.At the time the legal requirement for incorporation was that at least seven persons subscribe as members of the company i.e. as shareholders. Mr. Salomon himself was managing director. Mr. Salomon owned 20,001 shares of the company’s 20,007 shares ” the remaining six were shared individually between the other six shareholders (wife, daughter and four sons).

Mr. Salomon sold his business to the new corporation for almost 39,000 pounds, of which 10,000 pounds was a debt to him. He was thus simultaneously the company’s principal shareholder and its principal creditor. Later, when the company’s business failed and it went into liquidation, Salomon’s right of recovery (secured through floating charge) against the debentures stood prior to the claims of unsecured creditors, who would, thus, have recovered nothing from the liquidation proceeds.

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To avoid such alleged unjust exclusion, the liquidator, on behalf of the unsecured creditors, alleged that the company was sham, was essentially an agent of Salomon, and therefore, Salomon being the principal, was personally liable for its debt. In other words, the liquidator sought to overlook the separate personality of Salomon Ltd., distinct from its member Salomon, so as to make Salomon personally liable for the company’s debt as if he continued to conduct the business as a sole trader.Issues and questionsSeparate Legal Personality (SLP) is the basic tenet on which company law is premised. Establishing the foundation of how a company exists and functions, it is perceived as, perhaps, the most profound and steady rule of corporate jurisprudence.The case concerned claims of certain unsecured creditors in the liquidation process of Salomon Ltd., a company in which Salomon was the majority shareholder, and accordingly, was sought to be made personally liable for the company’s debt.Hence, the issue was whether, regardless of the separate legal personality of a company, a shareholder/controller could be held liable for its debt, over and above the capital contribution, so as to expose such member to unlimited personal liability.AnalysisCasesThe rule in the Salomon case that upon incorporation, a company is generally considered to be a new legal entity separate from its shareholders has continued till these days to be the law in Anglo-Saxon courts, or common law jurisdictions. The case is of particular significance in company law thus: Firstly, it established the canon that when a company acts, it does so in it’s own name and right, and not merely as an alias or agent of it’s owners. For instance, in the later case of Gas Lighting Improvement Co Ltd v Inland Revenue Commissioners, Lord Sumner said the following: “Between the investor, who participates as a shareholder, and the undertaking carried on, the law interposes another person, real though artificial, the company itself, and the business carried on is the business of that company, and the capital employed is its capital and not in either case the business or the capital of the shareholders. Assuming, of course, that the company is duly formed and is not a sham…the idea that it is mere machinery for affecting the purposes of the shareholders is a layman’s fallacy. It is a figure of speech, which cannot alter the legal aspect of the facts.” Secondly, it established the important doctrine that shareholders under common law are not liable the company’s debts beyond their initial capital investment, and have no proprietary interest in the property of the company. This has been affirmed in later cases, such as in The King v Portus: ex parte Federated Clerks Union of Australia, where Latham CJ while deciding whether or not employees of a company owned by the Federal Government were not employed by the Federal Government ruled that: “The company…is a distinct person from its shareholders. The shareholders are not liable to creditors for the debts of the company. The shareholders do not own the property of the company…” II Piercing of the veil by Common Law Courts.Lifting the veil of incorporation or better still; “Piercing the corporate veil” means that a court disregards the existence of the corporation because the owners failed to keep one or more corporate requirements and formalities. The lifting or piercing of the corporate veil is more or less a judicial act, hence it’s most concise meaning has been given by various judges. Staughton LJ, for example, in Atlas Maritime Co SA v Avalon Maritime Ltd (No 1) defined the term thus: “To pierce the corporate veil is an expression that I would reserve for treating the rights and liabilities or activities of a company as the rights or liabilities or activities of its shareholders. To lift the corporate veil or look behind it, therefore should mean to have regard to the shareholding in a company for some legal purpose.” Young J, in Pioneer Concrete Services Ltd v Yelnah Pty Ltd, on his part defined the expression “lifting the corporate veil” thus: “That although whenever each individual company is formed a separate legal personality is created, courts will on occasions, look behind the legal personality to the real controllers.” The simplest way to summarize the veil principle is that it is the direct opposite of the limited liability concept. Despite the merits of the limited liability concept, there is the problematic that it can lead to the problem of over inclusion, to the disadvantage of the creditors. That is to say the concept is over protected by the law. When the veil is lifted, the owners’ personal assets are exposed to the litigation, just as if the business had been a sole proprietorship or general partnership. Common law courts have the lassitude or exclusive jurisdiction “lift” or “look beyond” the corporate veil at any time they want to examine the operating mechanism behind a company. This wide margin of interference given common law judges has led to the piercing of the corporate veil becoming one of the most litigated issues in corporate law.But it should be worthy of note that a rigid application of the piercing doctrine in common law jurisdictions has been widely criticized as sacrificing substance for form. Hence, Windeyer j, in the case of Gorton v Federal Commissioner of Taxation, remarked that this approach had led the law into “unreality and formalism.” As aforementioned, when the judges pierce the veil of incorporation, they accordingly proceed to treat the company’s members as if they were the owners of the company’s assets and as if they were conducting the companies business in their personal capacities, or the court may attribute rights and/or obligations of the members on to the company. The doctrine is also known as “disregarding the corporate entity”. In his 1990 article, Fraud, Fairness and Piercing the Corporate Veil, Professor Farrar remarked that the Commonwealth authority on piercing the corporate veil as “incoherent and unprincipled”. That claim has been earlier backed up by Rogers AJA, a year ago in the case of Briggs v James Hardie & Co Pty thus: “There is no common, unifying principle, which underlies the occasional decision of the courts to pierce the corporate veil. Although an ad hoc explanation may be offered by a court which so decides, there is no principled approach to be derived from the authorities.” Another scholar in the person of M. Whincop in his own piece: ‘Overcoming Corporate Law: Instrumentalism, Pragmatism and the Separate Legal Entity Concept’, argued that the main problem with the Salomon case was not so much the argument for the separate legal entity, but rather the failure by the English House of Lords to give any indication of “What the courts should consider in applying the separate legal entity concept and the circumstances in which one should refuse to enforce contracts associated with the corporate structure.” IMPLICATIONSCommencing with the Salomon case, the rule of SLP has been followed as an uncompromising precedent in several subsequent cases like Macaura v Northern Assurance Co. , Lee v Lee’s Air Farming Limited, and the Farrar case. The legal fiction of corporate veil, thus established, enunciates that a company has a legal personality separate and independent from the identity of its shareholders. Hence, any rights, obligations or liabilities of a company are discrete from those of its shareholders, where the latter are responsible only to the extent of their capital contributions, known as limited liability. This corporate fiction was devised to enable groups of individuals to pursue an economic purpose as a single unit, without exposure to risks or liabilities in one’s personal capacity. Accordingly, a company can own property, execute contracts, raise debt, make investments and assume other rights and obligations, independent of its members. Moreover, as companies can then sue and be sued on its own name, it facilitates legal course too. Lastly, the most striking consequence of SLP is that a company survives the death of its members.

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