Case of Salomon v Salomon & Co. Ltd

Background

Salomon v Salomon Co. Ltd case has gained importance as it was the case recognizing the corporation as a distinct entity from the persons constituting the company. Salomon was carrying on the business as a leather merchant and boot manufacturer for quite some time. At a certain point in time, he incorporated a company and sold his private business to the company. Salomon and his family members were the shareholders of the company, with Salomon holding the majority of shares in the company (Chapter 3, 2006). Salomon received the shares as a part of the consideration for the sale of his business to the company. He was also distributed debentures by the company which constituted security for the other part of the consideration. The company complied with all the statutory compliance for registration and was working profitably. The business was carried on for some time and eventually, it became insolvent. When the company became insolvent Salomon claimed that he should receive the balance of his sale consideration before settling the secured creditors, since it was secured by the debentures. The appeal court looked at the creation of the company as a plan made out to limit the liability and advance the claim of Salomon before that of the creditors. However, the House of Lords upheld that Salomon & Co. Ltd has been formed legally satisfying all the requirements and therefore be considered as a separate legal entity. There was no evidence of deception or fraud detected. Salomon also proved that he did not have to indemnify the company, in respect of its debts as it had a separate legal personality.

Corporate Personality

The case of Salomon v Salomon & Co. Ltd deals with the area of Corporate Personality. The concept of corporate personality implies that with respect to the legal position the company is regarded as a separate entity that is in existence in reality. Because of this position the company is entitled to the right of bringing legal action against anyone and also is subject to legal suits brought by the third parties against it. It can hold properties in its own name and is also liable for its own debts. This case establishes the fact that a company established in compliance with the regulations of the Companies Act is a separate legal person and cannot be considered as the agent or trustee of its controller. Because of this situation, the company will become responsible on its own to settle monies owed by the company to outsiders and the members will not personally incur any liability. The case of Salomon deals more precisely with the concept of limited liability which enables the shareholders of the company to have limited liability, implying that the debts belong to the legal entity of the company (Dignam & Lowry, 2006).

Applicability of Salomon Case to Other Corporations

The ruling in the case of Salomon v Salomon acquires great significance in respect of all the other corporations. This ruling has become the accepted authority for the courts to follow the concept that a company incorporated properly would become a distinct corporate personality. The case of Salomon v Salomon has made it clear that on registration a separate and distinct legal entity is created. The concept of limited liability embedded in the company form of organization was given legal recognition only on the basis of the decision in this case and to this extent, this case becomes important for all the companies. The decision in Solomons case has laid down the fact that a registered company is a separate and distinct legal person and it has its existence different from the persons who founded the company. This protects the interest of the shareholders and directors of the company from incurring any liability on behalf of the company. The recognition granted to a corporation as a separate legal entity in its own rights formed the foundation for the development of modern company law and this marks the significance of the decision for the present-day companies (Murdoch University, 2000).

Other Significant Cases

There are many other cases decided by the courts following the ruling in the case of Salomon v Salomon. Some of the important cases are discussed below:

Tate Access Floors Inc. v Boswell [1991] Ch 512

In this case, it is clearly ruled that when people choose the company form of organization for conducting the business affairs, it is evident that the people forming the organization are taking the advantage of the fact that such corporations are considered as separate legal entities. In this case, the property and actions are governed by law and not by the actions or properties of the incorporators or the controlling shareholders. This clearly supports the principle established in Salomon v Salomon (Sealy & Worthington, 2007, p 53).

Macaura v Northern Assurance Co Ltd [1925] AC 619

Here the major shareholder of the company insured the assets of the company in his own name and on fire destroying the assets claimed under the policy against his unsecured debt from the company. It was held that the shareholder does not have an insurable interest. Since he could have insured either as a creditor or as a shareholder of the company, in either case, there is no insurable interest in respect of an asset which the company holds. This is due to the fact that the company is an independent legal entity and hence can hold properties in its own name unencumbered by the creditor or shareholder (Wild & Weinstein, n.d.).

Lee (Catherine) v Lees Air Farming Ltd [1960] 3 All ER 420

In the cited case Mrs. Lee Catherine claimed compensation for the death of her husband Lee who formed a company for doing the business of crop spraying from the air and was also the only pilot of the company. Lee was killed while piloting an aircraft during the course of working on the crop spraying. Mr. Lee owned the majority of the shares of the company and was also acting as the governing director of the company. Soon after the company was formed Lee appointed himself as the pilot of the company. The question was to decide whether there existed the relation of employer and employee between Lee and the company and therefore Mrs. Lee was entitled to any compensation. Applying the principle of Salomon v Salomon & Co it was held that Mrs. Lee would be entitled to compensation as the company was a separate legal person having the right to appoint anyone for carrying out the business of the company. The court ruled that the corporation and Mr. Lee were having separate legal personalities. Therefore it followed that they can enter into legally enforceable contracts with each other. The employment contract between the company and Mr. Lee can therefore be recognized as a contract that can be enforced under the law giving rise to an employer-employee relationship (Case Update, 2003).

In all the above cases and in several other judgments pronounced by various courts, the principle that the company once registered gets a legal personality separate from the persons forming or investing in the company has been clearly established. This principle has laid a strong foundation for the development of modern company law in which the doctrine of limited liability has been the central focus. To this extent the ruling in Salomon v Salomon & co. Ltd has been significant.

Piercing the Corporate Veil

There are several occasions where it seems that the principle laid down in Salomons case becomes unfair and therefore may not be applicable. In these cases, the courts applied different views against the principle laid down in the Salomon case and gave rulings that did not confirm the decision in the Salomon case. The courts used several grounds to arrive at such different decisions. This situation is termed as piercing the corporate veil.

Under Section 30 (3) of the Landlord and Tenant Act 1954, in cases where the landlord is having a majority of shareholding in a company controlling its activities, then it is deemed that the landlord himself carries on the business as distinct from the company. This provision does not recognize the existence of two different legal entities in this case.

Section 24 of the Companies Act 1985 read with Companies (Single Member Private Limited Companies) Regulations 1992, gives a different view. Under this section, the distinct legal entity of a company will be lost in cases where there is a reduction in the number of members of a public or unlimited company below the statutory minimum of two. For applying this section such reduction in the number of members should continue for a period exceeding six months. In such a case then the person who continues to be the single member of the company becomes jointly and severally liable for the debts of the company. In this case, the concept of a separate legal entity is disregarded.

Companies Directors Disqualification Act, 1986 is another instance where the liability of the company extends to individuals. According to the provisions of this legislation, when a person acting as a director of the company while being an undischarged insolvent, or is being under the directions of any court to not to act in such capacity, the person becomes jointly and severally liable for the debts of the company along with the company. This provision extends the area of claims for those who want to claim against such companies.

In the case of Smith, Stone, & Knight v Birmingham Corporation¹ the court ordered for the payment of compensation by the subsidiary company to the parent company. In this case, the subsidiary company was to be considered as an agent of the parent company. Also in the case of DHN Food Distributors Limited v London Borough of Tower Hamlets², the court ruled against the action of the parent company to bring legal action against the subsidiary company. The court ruling also provides for compensation from the subsidiary to the parent company.

In another landmark ruling in the case of Adams v Cape plc³ the court denied the existence of the condition of an agency in favor of the parent company just because of the fact that there is a majority shareholding by the parent company in shares in a subsidiary company. It has been the practice that the courts decide on the circumstances of each case whether the principle laid down in Salomons case is to be followed or not. In the case of Adams v Cape plc, the court was of the opinion that the concept of the corporate veil can be overlooked only in certain circumstances. The court can do so where there are situations that point out that the company is formed as a false entity to conceal facts or limit the liability.