Salomon v A Salomon & Co Ltd [1896] UKHL 1

Salomon v A Salomon & Co Ltd [1896] UKHL 1; [1897] AC 22

Court: House of Lords | Judgment: 16 November 1896

A company did not lose its separate legal identity because one shareholder controlled almost all its shares. The House of Lords rejected an order requiring Aron Salomon to indemnify his company against its debts. The company had been validly incorporated under the Companies Act 1862, and the statute did not require its seven members to have independent or substantial financial interests. The company’s separate attempt to set aside the business purchase also failed.

The business, shares and secured debt

Salomon had run a successful boot and shoe business as a sole trader. In 1892 he transferred it to A Salomon & Co Ltd. The memorandum was signed by Salomon, his wife, his daughter and four sons, each subscribing for one share. Salomon subsequently received another 20,000 fully paid shares. He therefore held 20,001 of the company’s 20,007 issued shares. No shares were offered to the public.

The purchase arrangements also gave Salomon £10,000 in debentures secured over the company’s assets. His position as a secured creditor was distinct from his position as a shareholder: the debentures represented a debt owed by the company and gave security for its repayment.

Trade deteriorated and the company encountered financial difficulties. Salomon raised £5,000 from Broderip against the debentures and lent that money to the company. When interest went unpaid, Broderip obtained a receiver. The company’s assets realised enough to pay Broderip but not the debentures in full, leaving the unsecured creditors unpaid.

Why the lower courts made Salomon liable

The liquidator initially sought to undo the business purchase and debentures for fraud. An alternative allegation that Salomon’s shares had not been paid for was no longer disputed at trial: the shares were fully paid. Vaughan Williams J suggested a different basis of recovery, which was added to the company’s counterclaim.

The judge treated the company as Salomon’s agent. On that reasoning, it had incurred debts on his behalf and was entitled to an indemnity from him. He ordered Salomon to pay £7,733 8s 3d.

The Court of Appeal upheld the result but adopted a different analysis. It treated the company as trustee for Salomon rather than his agent. It considered the arrangement a scheme enabling him to continue his business with limited liability, and obtain priority through the debentures, contrary to the intended operation of the Companies Act 1862. Salomon appealed. The company cross-appealed to pursue its claim to rescind, or set aside, the purchase.

What incorporation changed

The House of Lords unanimously rejected the indemnity. The starting point was what Parliament had enacted. Section 6 permitted seven or more persons associated for a lawful purpose to form a company by subscribing a memorandum and complying with registration requirements. Section 8 required each subscriber to take at least one share. Those requirements had been met.

The Act did not require equal shareholdings, unrelated members, or seven people exercising independent control. Nor did it require each member to have a substantial beneficial interest. Lord Halsbury refused to add conditions merely because the judges below thought that a company dominated by one person should fall outside the legislation.

Incorporation created a legal person distinct from its members. The business and its liabilities belonged to that person. Lord Macnaghten explained that continuing the same business, with the same managers and recipients of profits, did not make the company its shareholders’ agent or trustee. Members’ liability was governed by the Act; control alone did not create an obligation to pay the company’s debts.

The lower courts’ reasoning also contained a difficulty. They treated the company as sufficiently separate to claim an indemnity from Salomon, yet denied the consequences of its separate existence when deciding whose business it carried on. Lord Herschell observed that the same reasoning could impose unlimited liability on former partners who converted their businesses into companies. The statutory benefit could not depend on whether control rested with one dominant member or several.

The purchase and debentures

The company’s cross-appeal failed too. The shareholders knew and approved the terms on which the business was purchased. The judges did not all describe the valuation in the same way, but an allegation that the price was excessive did not establish fraud on this company in those circumstances. Lord Davey stressed the unanimous assent of the members to a transaction within the company’s powers.

Erlanger v New Sombrero Phosphate Co was distinguishable. That case involved shareholders misled about a purchase arranged through the vendor’s nominees. Here, the members were informed participants. Lord Macnaghten also considered that the company could no longer restore the business property, which had been sold.

Taking debentures as part of the purchase price was not itself unlawful. A member acting in good faith could hold the company’s secured debt. The House found no established fraud on creditors. The statutory information available to creditors disclosed the company’s arrangements; their failure to investigate did not make Salomon dishonest.

This did not mean the judges ignored the unsecured creditors’ losses. Lords Herschell and Macnaghten recognised the difficulties created when secured debentures exhausted the assets. Their concerns about possible legislative reform did not justify changing the rights conferred by the legislation they were applying.

Outcome

The House of Lords reversed the Court of Appeal’s order and dismissed the company’s cross-appeal, with costs, subject to the rules governing Salomon’s proceedings as a pauper in the House. The case was remitted to the Chancery Division. Salomon was not required to indemnify the company against its debts, and the business purchase was not set aside.

Source: Full House of Lords judgment on BAILII.