company law Cases

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Salomon v A Salomon and Co Ltd [1897] AC 22 Case Summary

Introduction

Separate 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. Contrastingly, the rule of "SLP" has experienced much turbulence historically, and is one of the most litigated aspects within and across jurisdictions.1 Nonetheless, this principle, established in the epic case of Salomon v Salomon,2 is still much prevalent, and is conventionally celebrated as forming the core of, not only the English company law, but of the universal commercial law regime.

Commonly known as: Salomon v Salomon

FACTS

Salomon transferred his business of boot making, initially run as a sole proprietorship, to a company (Salomon Ltd.), incorporated with members comprising of himself and his family. The price for such transfer was paid to Salomon by way of shares, and debentures having a floating charge (security against debt) on the assets of the company. 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 aprior to the claims of unsecured creditors, who would, thus, have recovered nothing from the liquidation proceeds.

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.

ISSUE

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 identity 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.

RULING

The Court of Appeal, declaring the company to be a myth, reasoned that Salomon had incorporated the company contrary to the true intent of the then Companies Act, 1862, and that the latter had conducted the business as an agent of Salomon, who should, therefore, be responsible for the debt incurred in the course of such agency.

The House of Lords, however, upon appeal, reversed the above ruling, and unanimously held that, as the company was duly incorporated, it is an independent person with its rights and liabilities appropriate to itself, and 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".3 Thus, the legal fiction of "corporate veil" between the company and its owners/controllers4 was firmly created by the Salomon case.

IMPLICATIONS

Commencing with the Salomon case, the rule of SLP has been followed as an uncompromising precedent5 in several subsequent cases like Macaura v Northern Assurance Co.6, Lee v Lee's Air Farming Limited,7 and the Farrar case.8

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.9 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".10 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.11 Accordingly, a company can own property, execute contracts, raise debt, make investments and assume other rights and obligations, independent of its members.12 Moreover, as companies can then sue and be sued on its own name, it facilitates legal course too.13 Lastly, the most striking consequence of SLP is that a company survives the death of its members.14

The Exception of Veil Piercing

Notably, similar to most legal principles, the overarching rule of SLP applies with exceptions, where the courts may look through the veil to reach out to the insider members, known as "lifting or piercing of the corporate veil".15

It is worthwhile here to refer to the case of Adams v Cape Industries16, which examined the common law grounds, primarily evolved through case law as an equitable remedy,17 namely- (a) agency, (b) fraud, (c) façade or sham, (d) group enterprise, and (e) injustice or unfairness. The exception has been invoked widely by English courts, including in the recent cases of Caterpillar Financial Services (UK) Limited v Saenz Corp Limited, Mr Karavias, Egerton Corp.18, Beckett Investment Management Group v Hall,19 Stone & Rolls v Moore Stephens,20 and Akzo Nobel v The Competition Commission,21 to cite a few. Needless to mention, the journey of English law in defining the contours of the SLP doctrine and carving out these exceptions has been quite topsy-turvy. Moreover, veil piercing is now also rampant as a statutory exception.22

So, considering the gamut of statutory and judge made exceptions above, has the Salomon rule become redundant?

March back to the Salomon rule

While the Salomon rule appears to have been eroded substantially, a reversal in the judiciary's approach, commencing with the Adams case, is now visible.

For instance, in Bank of Tokyo v Karoon,23 the Court of Appeal rejected the "single economic unit" theory arguing that "we are concerned not with economics but with law. The distinction between the two is, in law, fundamental and cannot here be abridged". Further, in the case of VTB Capital Plc v Nutritek International Corporation,24 the court reiterated the restricted scope of veil piercing as only a limited equitable remedy.

On a similar note, in the most recent judgment of Prest v Petrodel25, Sumption J. confined the lifting of veil to only two situations, namely, (a) the "concealment principle", akin to the sham or façade exception; and (b) the "evasion principle", being the fraud exception.26 Deciding not to pierce the corporate veil on the facts, this case once again reinstated the Salomon rule.

Conclusion

All in all, the Salomon ruling remains predominant and continues to underpin English company law. While sham, façade and fraud primarily trigger the invocation of the veil piercing exception in limited circumstances, these grounds are not exhaustive, and much is left to the discretion and interpretation of the courts on case-to-case basis.

Footnotes

1 Max Radin, 'The Endless Problem of Corporate Personality' (1932) 32 Colum. L. Rev. 643.

2 1897 AC 22.

3 Ibid 30-31 (Lord Halsbury LC). See also, Gas Lighting Improvement Co. Ltd. v Commissioners of Inland Revenue, 1923 AC 723 (Lord Sumner).

4 Jennings v Crown Prosecution Service, 2008 UKHL 29.

5 Marc Moore, 'A Temple Built on Faulty Foundations: Piercing the Corporate Veil and the Legacy of Salomon v Salomon' (2006) JBL 180.

6 1925 AC 619.

7 1961 AC 12.

8 Farrar v Farrars Ltd., (1888) 40 ChD 395.

9 Murray A. Pickering, 'The Company as a Separate Legal Entity' (1968) 31 Mod. L. Rev. 481.

10 P.W. Ireland, 'The Rise of the Limited Liability Company' (1984) 12 International Journal of the Sociology of Law 239.

11 Ayton Ltd. v Popely, 2005 EWHC 810 (Ch).

12 Farrar (n 8). See also, John Lowry & Arad Reisberg, Pettet's Company Law: Company Law and Corporate Finance (4th edn, Pearson 2012).

13 Metropolitan Saloon Omnibus Co. Ltd. v Hawkins, (1859) 4 Hurl & N 87.

14 Re Noel Tedman Holdings Pty Ltd., 1967 Qdr 561. See also, Mayson, French & Ryan, Company Law (29th edn, OUP 2012).

15 English courts have, however, differentiated between the terms "lifting" and "piercing", for instance, in Atlas Maritime Co SA v Avalon Maritime Ltd (No 1), court stated that "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, on the other hand, should mean to have regard to the shareholding in a company for some legal purpose", 1991 4 All ER 769, 779, (Staughton LJ).

16 1990 Ch. 433.

17 Peter B.Oh, 'Veil-Piercing Unbound' (2013) 93 B.U. L. Rev. 89.

18 2007 I.C.R. 1539 (A.C.).

19 2009 1 A.C. 1391.

20 2009 UKHL 39.

21 2013 CAT 13 (21 June 2013).

22 Sections 993 (fraudulent trading), 1121 (officers in default), 251 (shadow director), 399 and 409 (group reporting) of the Companies Act 2006. Further, section 214 of the Insolvency Act attributes unlimited liability to a director of a company in case of wrongful trading. See also, section 218(6) of the Employment Rights Act, 1996; Part 4- Taxation, International and Other Provisions Act, 2010; and Part 3- Finance Act, 2015. Also, see HM Revenue and Customs, Diverted Profits Tax: Interim Guidance, 30 March 2015.

23 1987 A.C. 45, 64.

24 2013 UKSC 5.

25 2013 UKSC 34.

26 Restricting to these two situations was, however, not consented to by all the judges on bench. For instance, Mance J. stated -"It is .... often dangerous to seek to foreclose all possible future situations which may arise and I would not wish to do so".