Salomon Case

Page 1

Basic facts:

Aaron

Salomon was a successful leather merchant

in Whitechapel who specialized in manufacturing leather boots. For many years he ran his business as a sole

trader/sole proprietor under name A. Salomon & Co.

By 1892, his sons had become interested in taking part in the business. Salomon

decided incorporate his business as a limited liability company in accordance

with the requirements set out in the Companies

Act 1862 (UK). At the time the legal requirement

for incorporation was that at least seven persons subscribe as members of a

company i.e. as

shareholders.

The

company was called Salomon & Co. Ltd.

The 7 shareholders were Mr.

Salomon, his wife, daughter and four sons.

Two

of his sons became directors. Mr.

Salomon himself became 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 (one share each). - majority shareholder

Mr.

Salomon sold his business to the new corporation for almost £39,000, of which

£10,000 was a debt to him. According to the Court, this was

"extravagant" and not "anything that can be called a business

like or reasonable estimate of value." (He should have got a valuation to show it was a legitimate transaction)

Parts

of the sale proceeds went to pay Salomon’s [then] personal business

creditors.

In

effect Salomon received about £1,000,

£10,000 in debentures and just over half the company’s shares.

He

was thus simultaneously the company's principal shareholder, managing

director and its principal creditor.

When

company failed, Liquidator argued that the debentures used by Mr.

Salomon as security for the debt were invalid, on the grounds of fraud.

The initial High Court Judge, Vaughan Williams J. accepted this

argument, ruling that since Mr. Salomon

had created the company solely to transfer his business to it, the company was in reality his agent and

he as principal was personally liable for debts to unsecured

creditors.

Salomon appealed: The Lords 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.

Court

of Appeal thus generally upheld the original High Court decision, so Salomon further appealed to

House of Lords.

Salomon

v. Salomon & Co. Ltd

[1897] A.C. 22 (H.L.)

Result:

He was found not liable because he followed the law and the company was a separate legal entity, so the director Mr. Salomon was not personally liable for the debts

The House of Lords unanimously

overturned this decision, rejecting the arguments regarding agency and

fraud. [This

highest level decision is the key decision] [1897]

A.C. 22 (H.L.)]

The

House of Lords held that the company was not an agent of Salomon; it was a separate legal entity as

permitted

by the legislation.

The

House of Lords also found no evidence of fraud.

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."

Lord

MacNaughton: "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.

Lord

MacNaughton: “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.”

So

the HL recognised the separate existence of the company -

S

had legitimately formed the company to give his sons an interest in the

business.

Also

S had not gained – he ended up a pauper having gained nothing out of creating

the company. The

principle

of this case has formed the foundation of company law in that it firmly set

down judicial endorsement of a company being a separate legal entity.

Principle:

The principle of this case is that a company is a separate legal entity

The reason this case is still relevant today is because the

principle

of this case has formed the foundation of company law in that it firmly set

down judicial endorsement of a company being a separate legal entity. Section 15 Companies Act 1993

Legal issue: Whether the corporate veil should be lifted and Mr Salomon be held liable. The High Court said that the company was merely an agent, it was a mere scheme and the liquidator also argued that Mr. Salomon used the company to perpetrate fraud. All of these 3 reasons are the broad areas when the corporate veil can be lifted - whether Mr. Salomon was personally liable for the debts or if the company was.

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