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State The Principles Laid Down In Salomon vs. Salomon Case

Introduction

Separate Legal Personality (SLP) is the core principle on which company law is based. Establishing how a company exists and establishes the foundation of actions is considered, it is perceived as, perhaps, the most profound and steady rule of corporate jurisprudence. In contrast, the rule of “SLP” has historically experienced and is one of the most litigated aspects within and across jurisdictions. However, this principle, established in the epic case commonly known as Salomon vs. Salomon[1], is still very prevalent and is conventionally celebrated as forming the core of, not only the English company law but of the universal commercial law governance.

The concept of separate legal personality basically states that when a company receives a certificate of incorporation it has a ‘separate legal personality’. In law, the company becomes a legal person it is its own right. The basic concept to be familiar with when starting up a business is the idea that the business itself has a legal personality in its own right, especially when it is in the form of a limited liability company.

This essentially means that if one starts a business as a limited liability company, then the corporation or company is a legal entity with a distinct legal personality separate to that of the owners, members, or shareholders. This is known as the concept of “legal personality”.

Facts of the Case

In this case, Salomon transferred his business of boot making, initially run as a sole proprietorship, to a company (Salomon Ltd.), that included himself and members of his family. Salomon was paid the price of such a transfer 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 to recover (secured through a floating charge) against the debentures stood for the claims of unsecured creditors, which would, thus, have recovered nothing from the liquidation proceeds. To avoid such alleged unfair 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 disregard the distinct personality of Salomon Ltd., separate from its member Salomon, so that Salomon would be personally liable for the debts of the company as if he continued to conduct business as a sole trader.

Issue of Salomon vs. Salomon case

This case asserts the 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 debts of the company. Therefore, the issue was that a shareholder/controller regardless of the separate legal identity of a company could be held liable for its debt, over and above the capital contribution so that such member can be exposed for unlimited personal liability.

Observation

The principle which is derived from the Salomon Case, commonly known as Salomon vs. Salomon & Co Ltd in which the House of Lord held that there is a separation of liability between a company and its shareholders, so the shareholders of a company can not be sued for the failure or liability of its company other than their participation.

In other words, the Salomon vs. Salomon case indicated that a company has its own legal personality that is separated from its shareholders, so the shareholders or the members are not liable for the debts of its company. The Salomon Principle basically gave protection to the shareholders, directors or other company members which are known as “Corporate Veil”[2].

The following principles which were laid down by the Lordships in this case are as follows:

  1. In order to form a company limited by shares, a memorandum of Association should be signed by seven persons.
  2. Every such person should possess at least one share each.
  3. If the above-mentioned requirements are complied with it hardly makes any difference whether the signatories are relations or strangers.
  4. The company is at law a different person together from the subscribers of the memorandum of Association.
  5. The statute enacts nothing as to the extent or degree or interest which may be held by each of the members.
  6. There is nothing in the Act; requiring that the subscribers to the memorandum of Association should be independent or unconnected or that they should have mind or will of their own.
  7. Act does not require anything like a balance of power in the constitution of the company.

Implications

Commencing with the Salomon case, the rule of SLP has been followed as an uncompromising precedent in several subsequent leading cases such as Macaura v Northern Assurance Co.[3], Lee v Lee’s Air Farming Limited[4] and the Farrar case[5].

The legal imagination of the corporate veil, thus established, indicates that a company has a legal personality that is separate and independent from the identity of its shareholders. Therefore, 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 contribution, known as “limited liability”. This corporate fiction was formulated 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.

Accordingly, a company can own property, execute contracts, raise debt, invest and assume other rights and obligations, independent of its members. Moreover, as companies can then sue and be sued on its own name, it facilitates legal course too. Finally, the most important result of SLP is that a company survives the death of its members.

Judgement of Salomon vs. Salomon case

A company is a separate legal entity separate from its members and so insulating Mr. Salomon, the founder of Salomon and Company, Ltd., from personal liability to the creditors of the company he founded himself. The court also upheld firmly the doctrine of corporate personality, as laid down in the Companies Act 1862, the Court also firmly upheld the principle of corporate personality, so that creditors of a bankrupt company would not have to sue the company’s shareholders to pay off the outstanding debt.

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

However, the House of Lords, on appeal, reversed the aforesaid judgement, 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 about”. Thus, the legal fiction of the “corporate veil” between the company and its owners/controllers was strongly created by the Salomon vs. Salomon case.

Conclusion

In conclusion, all in all, the Salomon ruling remains predominant and continues to underpin English company law. I think that however, that judges have different views in terms of different circumstances such as single companies as established in Salomon’s case to groups of companies by a comparatively recent decision of the Court of Appeal in the case Adams v Cape Industries[6], it is not necessarily becoming increasingly difficult to predict in a case, whether the courts will or will not follow the principle of separate corporate personality as confirmed in Salomon vs. Salomon case

However, I do feel that the veil of incorporation, even though not lifted at times, is becoming more ‘transparent’ in modern company jurisprudence but the veil has been pierced in many situations as discussed above. In the expanding horizon of modern jurisprudence, it is acceptable to lift the corporate veil and its frontiers are unlimited. However, this mainly depends on the realities of the situation. The aim of the legislation is to do justice to all the parties and therefore we can conclude that the principle of the doctrine of the lifting of corporate veil is expanding.

[1]UKHL 1, AC 22

[2] Companies Act,2013

[3]AC 619

[4] UKPC 33,AC 12

[5]40 ChD 395

[6]Ch 433

This Article is Authored by Kaushiki Ranjan, 4th Year BB.A LL.B(Hons.) Student at School of law, UPES, Dehradun.

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