Shoe Company with Shares

In brief,Mr Aron Salomon was a sole proprietor of his shoe and leather business. He was pestered by his sons because they were working for him as ‘slaves’ and were not all were his ‘partners’ and so each wanted a share.

That sparked him to form a limited liability company and consequently transferring his business to it.He did just that in 1892 and sold his business to the company.There was no issuing of shares to the public as it was ‘ private limited.’ Given that the law in that era required seven subscribers [2] to that memorandum, the subscribers were himself, his wife and their five children.And everybody except himself held one share in the company each.

He issued of 20,000 shares to himself in the company in consideration. Things took a downturn for him after that, unfortunately.He then, tried his best to resolve it by securing a debenture to pump money into the company.But the company instead became insolvent.He then took all of his debenture funds except some that was owed by his company to the creditors. The creditors were those who had been his clients from his sole proprietary business and now the limited liability company.

And when the creditors try to sue him, he told them that he was not the one that had owed them money and that for all he knows, the one who owed them was the corporation that exists as a ‘separate legal’ individual. He added that the shareholders are not at all responsible for the debts of the company as well. For this, the creditors argued that this was a ‘mom and pop shell company’ and nevertheless the same person. They then went on to establish their point by pointing out that the company was nonetheless a ‘one man company’.

The Court of Appeal held in favour of them and so Salomon had to compensate for the creditors as the company was held to be “mere nominee and agent” of himself. The court in interpreting took the approach of looking in to what the legislators had intended with the legislation. However, when the case went up to the House of Lords [3] , the Lords unanimously ruled and took the literal approach [4] by applying the statute at that time with the facts and decided that a company is to be regarded and treated as being independent from its incorporators. And as per Lord MacNaughten in this case, “ ..the company attains maturity on its birth..(in the eyes of law) the company is (independent) altogether from the subscribers to the memorandum and […] the company is not in law, the agent of the subscribers or trustee for them.”And the outcome of this decision had the most impact towards company law.

It was regarded as being utmost importance especially in providing clarity to the doctrine of incorporation as it was not quite clear during that time in law as to what the aftermath were [5] .

According to the doctrine, once a company is incorporated, it would be regarded as a ‘separate legal entity’. Meaning, a company and its members would not be regarded as being conjoined but disjoined instead. And the member’s liability in the company would be limited which then brings the concept of limited liability.

This concept seeks to protect the company also of its members by allowing the company to go about its commercial ventures that it wishes to pursue.Thus,that ‘legal person’ would be able to enjoy the advantages of corporate personality as well as limited liability provided the Companies Act requirements are met.

In addition,the Salomon case allows debentures to be used by investors as a ‘shield’ to futher stay away from losses.

Also, a company would have never-ending succession. But that is provided it would not result in being wound up or deregistered.

Futhermore, the company as well as its members are subject to being sued and are liable to debts individually and not as a whole.This could be seen in the case of Foss v Harbottle [6] .

Besides that,the property,assets as well as rights do not belong to the shareholders but the company.This could be seen in Macaura v Nothern Assurance Co Ltd [7] .

The company could also enter in to contract with its own shareholders.And the case for example is Lee v Lee’s Air Farming Ltd [8] .

As a result, it is said that there is a veil between the shareholders and creditors.And if the veil is lifted by the courts, the liability would be placed on the members for the company’s wrong and there would be no separation of personality for the company as well as its members.In short, the outcome of Salomon as mentioned, would be referred as the ‘Salomon principles’.

In reference as to whether this case had caused ‘injustice towards the business community’ as well as created an ‘irresponsibility behaviour’ would be argued below as it may have done so.

The Salomon case was heavily criticised not anything but because of what was intended as an advantage for the business community has been abused with the irresponsible behaviour of some who commit acivities of fraudulent nature and are sometimes untouchable by the Salomon principle.

One example is the situation where the companies goes into insolvent liquidation. And usually the workers are then dismissed from the company and the directors would have gathered as much in their bank accounts that could feed their future generations. And with the Salomon principle, since the directors do not represent the corporation, their assets cannot be touched. This shows that how the Salomon principle could cause injustice as well as a tidal wave of irresponsibility to the business community in this sense.

In Gilford Motor Co Ltd v Horne [9] , for instance, the ‘irresponsibilty’ could be seen when in order to avoid a valid restraint on trade clause which would be imposed by his ex-employer, a company was created by Horne.As well as in Jones v Lipman [10] , where here in order to avoid a specific performance of a contract, a company was formed.

Another instance is the case where Harman J regarded the following as ‘a barefaced attempt’in attacking even the fundamental company rule.In Re Bugle Press Ltd [11] , two individuals held 90 per cent of the shares.The 10 per cent remaining was held by the third.The majority shareholders attempted to remove the minority shareholder.However, the shares of the minority could not be compulsorily acquired by them.In order, to make takeover bid to the shareholders in Bugle Press, a company was formed.And they then succeeded.

Legal academician Kahn-Freund [12] managed to capture this in his Modern Law Review article, and he argued that the decision made in Salomon as being ‘calamitious’.He approached it with two type of approaches.The first being what the society be able to benefit from the distribution as well of those who had invested of the profits, also of the measures taken to stop ill-treating the society with corporate fraudulent activities.Second, is the misuse of the corporate entity principle, of sale and purchase and issuing of shares and the putting down of the corporate capital with ‘funds that are guaranteed’ for overvalue of shares.And it is his view that the doctrine of incorporation to be kept expensive and for abolishing of smaller companies.

However, the reverse seems to have taken its place and hence the ‘tidal wave’. This is because as many companies begun to place their capital to the public with their assets that are overvalued, that many may have been be done for fraudulent purposes. Thus, the ones who makes the most of out it are the directors with money and the ones who do not are the rest.Similarly, funds could be obtained dishonestly by forming a company and then escape liability from paying the funds back. Hence, it seems impossible to be able to place liability on a ‘particular person’ because of the Salomon principle and so it provides as a tool to escape legal duties in a way as well.

Therefore,it can be concluded that the Salomon principle is a ‘double-edged sword’ as it allows the directors to ‘irresponsibily’ manipulate it for their own benefit as well as being an economic powerhouse.

As for whether by the courts hesistating in piercing the veil of the company except in certain circumstances and this is the ‘main strength of UK company law’ would be argued below.

First of all, it should be noted that the principles highlights what a single trader would be able to do as well as in terms of recognition of private company to be put into statutory footing. As such, the corporation further provides the structure for holding of family assets; continuing trusteship; fund management; corporatised government enterprise; and, the co-enjoyment of property [13] .And as for group of companies, with the Salomon ‘separate legal entity’ principle, all of the companies of a group are independent and would not be liable just because one of the group of companies went into insolvent liquidation. In addition, the investing public would be able to reap the profits without having to be involved with the management of the enterprise.

And this demonstrates that the Lords when deciding in Salomon, had the thoughts of expanding further of the uses of a company as well of what it was, and so the principles were intended to expand its uses in a good way. [14]

And so the courts may be hesistant to lift the veil in the certain circumstances where the small or private enterpises do not wish to gain capital from the public but wishes to have a veil between their creditors.

But this is subject to the legislation passed and takes effect only where it is done in the manner required by the Act, and even where only one person helds almost all the shares.

The courts may even allow the traders to not only limit their liability to the capital that they have invested in but also of the risks that comes with it that of subscribing to debentures and not shares.

However as aforesaid, the courts would not ‘lift the veil’ unless where as Lord Keith of Kinkel said in Woolfson v Strathclyde Regional Council [15] , that “only (if) special cicumstances exist”. Here, the court lifted the veil as the company was a “mere façade concealing true facts”. Meaning the company was formed to avoid its existing liabilities.

The courts are unpredictable however as to when precisely the veil would be lifted as there have been many circumstances where the Salomon principle was ignored.For instance in Smith,Stone & Knight v Birmingham Corporation [16] , where it was held by the court that the subsidiary was just its agent and the business was of the parent company.And, in the 1970’s, the courts were not hesistant to lift the corporate veil as it was done increasingly.

And when the judges took a more interventionist approach and ignoring the Salomon principles in this case where it held amongst others, that, sometimes a group of associated companies would be regarded as one in DHN Food Distributors Ltd v Tower Hamlets London Borough Council [17] .

Lord Keith of Kinkel in Woolfson [18] doubted that DHN would have been applied properly. And it brought about the necessity for the courts to establish which are the situations that would result in the court lifting the veil so that it could benefit the litigants to know possibly when. The case in Adams v Cape [19] of shed some light in this area as the Court of Appeal rationalized the exceptions further.

The court established that one of the exceptions in not lifting the veil would be if a company is formed in order to avoid its existing liabilities (i.e. a mere façade). Second exception in Adams is, if the subsidiary is ‘merely the agent’ of the corporation.Thirdly, where the ‘grounds of just’ is rejected by the courts as the cause of intervention, where there seems to be ‘less clarity’ when interpeting the statute or document.

The case for example for ‘mere façade’ is Jones v Lipman [20] .Here, a company was formed by the defendant in order to avoid a specific performance of the contract.The contract was for a sale of land.He then transferred the property to the company he formed to avoid the sale.For this, Russell J said “the creature of the First Defendant ( formed the company as) a device and a sham, a mask which he holds before his face in an attempt to avoid recognition by the eye of equity (i.e. his existing liabilities).” [21]

As for the second exception in Adams, though it was made clear in Salomon that there company cannot be an agent with its shareholders automatically.

In the case of Smith,Stone & Knight Ltd v Birmingham Corporation [22] , for instance, the principles of inferring agency between a subsidiary company and parent company was considered by Atkinson J. He identified the necessary six points to infer agency as:

“..The first point was: were the profits treated as the profits of the company?- secondly,(if the) persons (carrying out) the business appointed by the parent company? Thirdly, was the company the head and the brain of the trading venture? Fourthly, did the company govern the adventure, decide what should be done and what capital should be embarked on the venture? Fifthly, did the company make the profits by its skill and direction?Sixthly, was the company in effectual and constant control?”.

As for the ‘grounds of justice’ requirement, the Adams case was followed in Creasey v Breachwood Motors Ltd [23] . Here, the assets from Company A was converted to Company B.And this resulted in having the ex employee having a futile grounds of basis towards Company A.The judge felt by placing the defendant as company B would be ‘just to do so’ and with this reason had resorted to lift the veil. But the court in Ord v Belhaven Pubs Ltd [24] felt that the decision in the case of Creasey v Breachwood Motors Ltd [25] , had the wrong application of the lifting of veil principle, and thus, it was overruled. And this shows the departure of courts from the Adams principle.The court also stressed that the veil should be lifted when the company is a ‘sham’ or ‘façade concealling true facts.’

However the departure from Adams is futher evident of late, when Auld LJ in the case Ratiu v Conway [26] . He was of the view that the courts would be willing, in no matter what pertaining issue there is, to lift the veil on the basis of justice where logic and of the current circumstances needs it.

Similarly,the departure of the courts could also be seen in the case Samengo-Turner v J&H Marsh & McLennan (Services) Ltd. [27]

And, besides that, there is also an increasing amount of veil lifting because of the tortious liability issues. It was adressed by the Company Law Review Steering Group [28] (CLRSG) in its preliminary deliberations.

Suprisingly the CLRSG was of the view that with the Adams case that for involuntary creditors,the courts would be reluctant in lifting the veil and so there isnt a need for reforms. But the reality did not go in hand with the view of the CLRSG. It was noticed by Professor Muchlinski ( 2002) [29]

and in response to that, he said that the ‘involuntary creditors pleas and sufferings on personal injuries by overseas subsidiaries of United Kingdom based Multi-National Enterprises appears to have fallen silent to the Steering Group.

But the Group is more concerned on the cost-effective,pro-business, and of traditional shareholder based model of company law instead.’ And Professor Muchlinski (2000) managed to grab hold of this problem and said that “(instead of) considering the economic realities of the cases in issue…legal concepts in particular the trritorial nature of the legal jurisdiction and the single unit corporate form ( are relied upon).” [30] This shows that unfortunately the confusion remains. He was also of the view the outcome of this would be injustice to the lay persons who seek justice.But as to whether the Salomon principle has caused a tidal wave of injustice as well as for the irresponsibility of the business community, it is possible that these could be prevented with judicial intervention as well as by the Parliament.

And as a conclusion,it should be noted that the Salomon principle had indeed created many positive benefits and advantages as well and so the reluctance of the courts to lift the corporate veil could be said to be a strength of the UK company law in upholding the Salomon principle.It is difficult to determine if the benefits outweigh the disadvantages of it. The abuse of the Salomon principle by some is like ‘adding more straws on the camel’s back’.And as aforementioned, confusion as to when the courts would exercise its powers with that discretion remains because of the general view of the lack in definte circumstances where the veil would be lifted and the fact that the Company Law Review Steering Group did not really consider reform seems to be adding another straw to the camel’s back [31] .Nevertheless, the very old ‘frankenstein’ still remains to be part of UK company law and by the courts still upholds the corporate veil principle is still a main strength of UK company law.

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