company law

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Salomon v Salomon & Co. is a foundational

Aron Salomon was a successful leather merchant who specialized in manufacturing leather boots. For many years he ran his business as a sole proprietor. 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 a company i.e. as shareholders. Mr. Salomon himself was managing director. Mr. Salomon owned 20,001 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, of which £10,000 was a debt to him. He was thus simultaneously the company's principal shareholder and its principal creditor.

He asked the company to issue a debenture of £10,000 to him. However, a sudden slow down in business occurred and the company could no longer pay interests to Salomon. Even the wife puts money, but the company still cannot pay. Finally, Salomon transfers the debenture to one B, but still the company could not pay. B is here a secured creditor, in relation to the company, as he holds in respect of his a security over property of the company in term of the debenture. B called for a receiver and therefore, sold the easiest part of the company, i.e., the factory to cover his debts. That led to the end of the business. This left the debts of the general creditors, for instance, the general suppliers to be covered. The company had to be hence liquidated and the assets were to be sold to pay them.

When the winding up order was made the official receiver became liquidator unless and until an insolvency practitioner was appointed in his place. As a liquidator of a company, the official receiver's general functions were to investigate any wrong doing in the company, to secure the assets, realise them and distribute the proceeds to the company's creditors, and, if there is a surplus, to the persons entitled to it (normally the contributories). When the company went into liquidation, the liquidator argued that the debentures used by Mr. Salomon as security for the debt were invalid, on the grounds of fraud; Salomon was not a genuine incorporator.

High Court:

The judge, Vaughan Williams J. accepted this argument, ruling that since Mr. Salomon had created the company solely to transfer his business to it, prima facea, the company and Salomon were one unit; the company was in reality his agent and he as principal was liable for debts to unsecured creditors.

The appeal:

The Court of Appeal also ruled against Mr. Salomon, on the grounds that Mr. Salomon had abused the privileges of incorporation and limited liability, which the Legislature had intended only to confer on "independent bona fide shareholders, who had a mind and will of their own and were not mere puppets". The lord justices of appeal variously described the company as a myth and a fiction and said that the incorporation of the business by Mr. Salomon had been a mere scheme to enable him to carry on as before but with limited liability.

The Lords:

The House of Lords unanimously overturned this decision, rejecting the arguments from agency and fraud.

Salomon followed the required procedures to the set the company; shares and debentures were issued. The House of Lords held that the company has been validly formed since the Act merely required 7 members holding at least one share each.

It was irrelevant that the bulk of shares were issued to one shareholder. Statute did not mention that each share holder should have X amount of shares. It said nothing about their being independent, or that they should take a substantial interest in the undertaking, or that they should have a mind and will of their own, or that there should be anything like a balance of power in the constitution of the company. (In the Companies Act 2001, it is possible for one shareholder to set up a company, this is a one man show where he is himself the shareholder and the shareholder – closed company).

There was no fraud as the company was a genuine creature of the Companies Act as there was compliance and it was in line with the requirements of the Registrar of Companies.

The Company is at law a separate person. The 1862 Act created limited liability companies as legal persons separate and distinct from the shareholders. They held that there was nothing in the Act about whether the subscribers (i.e. the shareholders) should be independent of the majority shareholder. It was held that: "Either the limited company was a legal entity or it was not. If it were, the business belonged to it and not to Mr Salomon. If it was not, there was no person and no thing to be an agent [of] at all; and it is impossible to say at the same time that there is a company and there is not." Hence the business belonged to the company and not to Salomon, and Salomon was its agent.

The House further noted:

"The company is at law a different person altogether from the [shareholders] ...; and, though it may be that after incorporation the business is precisely the same as it was before, and the same persons are managers, and the same hands received the profits, the company is not in law the agent of the [shareholders] or trustee for them. Nor are the [shareholders], as members, liable in any shape or form, except to the extent and in the manner provided for by the Act."

b) Lee v. Lee's Air Farming Ltd. (1960) [1961] A.C. 12 (New Zealand P.C.)

The appellant's husband formed the respondent company for the purpose of carrying on the business of aerial top dressing. The nominal capital of the company was $ 3000 divided into 3000 shares of $ 1 each. Mr Lee held 2999 shares, the final share being held by a solicitor. Mr Lee was the sole ‘governing director” for life. He was the vast majority shareholder, he was the sole governing director for life and he was an employee of the company pursuant at a salary arranged by him. Article 33 also provided that in respect of such employment the relationship of master and servant should exist between him and the company.

The husband was killed while piloting the company's aircraft in the course of aerial top dressing. His widow, the appellant, claimed compensation under the New Zealand Workmen's Compensation Act, 1922. On a case stated for its opinion on a question of law, the New Zealand Court of Appeal held that since the deceased was the governing director in whom was vested the full government and control of the company, he could not also be a servant of the company. The widow appealed.

It was held:

The substantial question which arises is, as their Lordships think, whether the deceased was a "worker" within the meaning of the Workers' Compensation Act, 1922, and its amendments. Was he a person who had entered into or worked under a contract of service with an employer?

The company and Mr. Lee were distinct legal entities and therefore capable of entering into legal relations with one another. As such they had entered into a contractual relationship for him to be employed as the chief pilot of the company. They found that he could in his role of governing director give himself orders as chief pilot. It was therefore a master and servant relationship and as such he fitted the definition of ‘worker’ under the Act. The circumstance that in his capacity as a shareholder he could control the course of events would not in itself affect the validity of his contractual relationship with the company. Just as the company and the deceased were separate legal entities so as to permit of contractual relations being established between them, so also were they separate legal entities so as to enable the company to give an order to the decease. In their Lordships' view it is a logical consequence of the decision in Salomon's case that one person may function in dual capacities. The appeal was allowed and the widow was therefore entitled to compensation.     

c) Macaura v. Northern Assurance Co Ltd [1925] AC 619

The property of a company belongs to it and not to its members. Neither a shareholder nor a creditor of a company (unless a secured creditor) has an insurable interest in the assets of the company. Mr Macaura was the owner of the Killymoon estate in county Tyrone. In December 1919 he agreed to sell to the Irish Canadian Saw Mills Ltd, all the timber, both felled and standing, on the estate in return for the entire issued share capital of the company, to be held by himself and his nominees. He also granted the company a license to enter the estate, fell the remaining trees and use the sawmill. By August 1921, the company had cut down the remaining trees and passed the timber through the mill. The timber which represented almost the entire assets of the company, was then stored on the estate. On 6 February 1922 a policy insuring the timber was taken out in the name of Mr Macaura. On 22 February a fire destroyed the timber on the estate. Mr Macaura then sought to claim under the policy he had taken out. The Insurance company contended that he had no insurable interest in the timber as the timber belonged to the company and not to Mr Macaura. The House of Lords agreeing with the Insurance company, found that the timber belonged to the company and that Mr Macaura even though he owned all the shares in the company had no insurable interest in the property of the company. Lord Wrenbury stated that a member – “even if he holds all the shares is not the corporation and neither he nor any creditor of the company has any property legal or equitable in the assets of the corporation”.

4. Exceptions to the separate legal entity principle: “Lifting the corporate veil”

In a number of instances, the courts want to lift the veil to find out who causes the company to act. This is usually done for reasons of fraud. There are 2 types of lifting of the veil:

Judicial lifting (most important)

Statutory lifting

(i) Judicial Lifting

(a) Gilford motor company Ltd v. Horne [1933] Ch.935

Mr. Horne was an ex-employee of The Gilford motor company and his employment contract provided that he could not solicit the customers of the company after the termination of his employment (negative clause). In order to defeat this, he incorporated a limited company in his wife's name and solicited the customers of the company. The company brought an action against him. Horne argued that it was the company (as a separate legal personality) that was attracting the clients - not him.  The Court of appeal was of the view that "the company was formed as a device, a stratagem, in order to mask the effective carrying on of business of Mr. Horne" in this case it was clear that the main purpose of incorporating the new company was to perpetrate fraud. Thus the court of appeal regarded it as a mere sham to cloak his wrongdoings.

Avoidance of an existing legal duty F

While it is generally permissible to form companies to avoid a future liability, for example in a risky business venture that may fail, courts may not allow a company to be formed to avoid performing an existing legal duty.

(b) Jones v. Lipman [1962] 1 WLR 832

Mr Lipman had entered into a contract with Mr Jones for the sale of land.  Before the conveyance (the act of transferring the legal title in a property from one person to another), Mr. Lipman then changed his mind and did not want to complete the sale.  He formed a company and in an attempt to avoid the transaction, sold the land to the company, in which he and his sollicitor’s clerk were shareholders and directors. Lipman then claimed that he could not complete the transaction with Mr Jones since he no longer owned the land, i.e. the company was now the lawful owner.  The judge specifically referred to the judgments in Gilford v. Horne and held that the company here was "a mask which (Mr. Lipman) holds before his face in an attempt to avoid recognition by the eye of equity" he awarded specific performance both against Mr. Lipman and the company.

Read a summary of the Salomon v Salomon case here.