This Case Commentary is written by Maanya Singh, a Fourth-Year Law Student of Jaipur National University

Case Details:

Case Name: Salomon vs. Salomon & Co. Ltd.

Court: House Of Lords

Citation: (1897) A.C. 22, [1896] UKHL 1

Decided on: 16 November 1897

Facts

Salomon decided to transform his boot-making market from a sole trader into a firm he called Salomon Ltd. which he formed together with his family. Salomon was given shares and debenture stock in return for the shares with charged to the company assets for the change. When the business of the company failed and went into liquidation, the floating charge with Salomon took priority over all the other creditors who would not recover anything from the company’s liquidation.

To avoid this which they said was an unfair exclusion, the liquidator argued that the company was a mere ‘sham’, a vehicle for Salomon and therefore Salomon was liable for its debts personally. In other words, the liquidator desired to disregard the distinct legal personality of Salomon Ltd. except for its owner Salomon to sue Salomon for the company’s debts as if Salomon continued the business alone.

Issues

The case involved some of the unsecured creditors about the liquidation process of a business known as Salomon Ltd., a company in which the appellant was a majority shareholder and hence sought to be held personally liable for the company’s debts. Therefore, the question was whether, even assuming corporate personality, a shareholder/controller could be held responsible for a company’s debt, beyond capital subscription to render such member liable to infinity.

The two main issues that were raised based on the above facts were:

1. Whether Salmon & Co. Ltd. Was a legally valid company? 1.

2. Whether Salomon was liable for the debts of the company? Whether Salomon & Co. Ltd. was a legally valid company?

Ruling

In the Salomon vs. Salomon case, the House of Lords introduced a unanimous judgment that installed the principle of a company’s Separate Legal Entity.

l The court declared the company as a myth to be dismissed and reasoned that Salomon had incorporated the company for a purpose which was prohibited by the Companies Act; the latter had carried the business as an agent of Salomon who should be liable for the debts in the course of such agency.
This separation known as the Corporate veil minimizes the legal responsibility of the shareholders in relation to the monetary assets of the agency.
The judgment again brought into force that shareholders’ liability does not exceed the amount unpaid on the stocks.
1. This was the rude judgment that set the muse for regulation that shapes intercontinental corporate practices, as well as focusing on the role of limited liability in corporate structures.
Therefore, the Salomon vs Salomon case has firmly set the legal principle of “Corporate Veil” between the business entity and its shareholders.
2. The court of appeal dismissed the said company as a myth and opined that Salomon had incorporated the company contrary to the true spirit of what was envisaged under the then-existing Companies Act, 1862, and further observed that the above-named ‘Latter’ had carried on the business as an agent of Salomon and as such Salomon should be held liable for the amount owed by ‘Latter’ about such agency.
3. The House of Lords, however, upon appeal, reversed the above ruling, and unanimously held that the company, since it was incorporated, is an independent entity, to whom rights and liabilities belong, and that “the motives of those who participated in the promotion of this company are entirely irrelevant to the question of what these rights and liabilities are”. Halsbury L.C.[1] It has also been held that. Similarly, Gas Lighting Improvement Co. Ltd. v Commissioners of Inland Revenue[2]. Therefore, the legal notion of ‘separation between the company and its owners/controllers’; better known as the ‘corporate veil’ [ Jennings v Crown Prosecution Service, 2008 UKHL 29] was laid down with the judgment in Salomon’s case.

Implications

Commencing with the Salomon case, the rule of SLP has been followed as an uncompromising precedent5 in several subsequent cases like Macaura v Northern Assurance Co., Lee v Lee’s Air Farming Limited, and the Farrar case.

The legal fiction of corporate veil or corporate personality as thus defined states that a company has got legal entity different from that of its members. Therefore, any rights, obligations, or liabilities of a company are separate from those of its shareholders and the most that the shareholders can lose is the amount they put in their investment known as ‘limited liability.[3]’.This was a corporate entity created for people to organize and undertake an economic activity in a way that each one of them was not held legally accountable for losses in a personal capacity. Consequently, a company can acquire property, enter into contracts, borrow funds, make investments perform other activities, and bear other powers and duties on its behalf and for the benefit of the shareholders. Also, since companies can sue and be sued in their name, it aids legal course as well. Last but not least, the most dramatic upshot of SLP is that a company carries on existence despite the demise of its members.[4].

The Exception of Veil Piercing

The exception of Veil Piercing is a prison doctrine that allows positive instances to transcend the safety offered using the Corporate Veil in a bid to protect shareholders or directors involved in the actions or debts of an organization. The corporate veil generally protects shareholders from private liability and the exception, veil piercing, is called when there is an impairment of the corporate form or when justice requires that the persons behind the employer should be made responsible. Key conditions in which the court would possibly apply the exception of Veil Piercing are as follows :

Key conditions in which the court would possibly apply the exception of Veil Piercing are as follows:

1. Fraud or Wrongdoing: If the corporate shape is used to defraud, cover unlawful activities, or engage in wrongdoing the court may also pierce the corporate veil to establish those individuals involved.

2. Evasion of Legal Obligations: If a corporation is established or run with the motive of evading certain legal responsibilities inclusive of contractual or statutory ones, then the court can, in consultation, remove the corporate veil with a view of stopping injustice.

3. Alter Ego or Agency: In simple terms, it indicates that if a business enterprise is considered in law as an alter ego or mere agent of the proprietors without a real separate personality or entity, then the superior court may also lift the corporate veil to consider the steps taken by the company as that of persons behind it.

4. Under capitalization: Also, where an organization is under-capitalized, and it emerges that the organization is in a position to meet its economic obligations, the courtroom may also pierce the veil to protect the interests of the creditors.

5. Unfairness or Injustice: If the documents that created the Corporate Veil are not respected, then there will be unfairness or justice in the case and the courtroom can as well cause interference. This may be in situations where the organization used to protect a person’s property against valid claims.

As is the case with most legal rules, this also holds that SLP operates subject to exceptions, which allows the courts to go outside the veil to the insider members, which is referred to as the “lifting or piercing of the corporate veil”.

It is worthwhile here to refer to the case of Adams v Cape Industries.[5], which examined the common law grounds, primarily evolved through case law as an equitable remedy,[6]Namely- (a) agency, (b) fraud, (c) façade or sham, (d) group enterprise, and (e) injustice or unfairness. The exception has been invoked widely by English courts, including in the recent cases of Caterpillar Financial Services (UK) Limited v Saenz Corp Limited, Mr Karavias, Egerton Corp., and Beckett Investment Management Group v Hall.[7]Stone & Rolls v Moore Stephens, and Akzo Nobel v The Competition Commission, to cite a few. Needless to mention, the journey of English law in defining the contours of the SLP doctrine and carving out these exceptions has been quite topsy-turvy. Moreover, veil piercing is now also rampant as a statutory exception.[8]

So, considering the gamut of statutory and judge-made exceptions above, has the Salomon rule become redundant?

March back to the Salomon rule

While the Salomon rule appears to have been eroded substantially, a reversal in the judiciary’s approach, commencing with the Adams case, is now visible.

For instance, in Bank of Tokyo v Karoon,[9] The Court of Appeal rejected the “single economic unit” theory arguing that “we are concerned not with economics but with law. The distinction between the two is, in law, fundamental and cannot here be abridged”. Further, in the case of VTB Capital Plc v Nutritek International Corporation, The court reiterated the restricted scope of veil piercing as only a limited equitable remedy.

On a similar note, in the most recent judgment of Prest v Petrodel[10], Sumption J. confined the lifting of the veil to only two situations, namely, (a) the “concealment principle”, akin to the sham or façade exception; and (b) the “evasion principle”, being the fraud exception.[11]. Deciding not to pierce the corporate veil on the facts, this case once again reinstated the Salomon rule.

Conclusion

All in all, the Salomon ruling remains predominant and continues to underpin English company law. While sham, facade, and fraud primarily trigger the invocation of the veil-piercing exception in limited circumstances, these grounds are not exhaustive, and much is left to the discretion and interpretation of the courts on a case-to-case basis.

References

[1] Ibid 30-31

[2] 1923 AC 723 (This case is supported by Lord Sumner)

[3] P. W. Ireland, ‘The Rise of the Limited Liability Company’ (1984) 12 International Journal of the Sociology of Law 239.

[4] Metropolitan Saloon Omnibus Co. Ltd. V Hawkins [ 1859 ] 4 Hurl & N 87

[5] 1990 Ch. 433.

[6] Peter B.Oh, ‘Veil-Piercing Unbound’ (2013) 93 B.U. L. Rev. 89.

[7] 2009 1 A.C. 1391.

[8] Sections 993 (fraudulent trading), 1121 (officers in default), 251 (shadow director), 399 and 409 (group reporting) of the Companies Act 2006. Further, section 214 of the Insolvency Act attributes unlimited liability to a director of a company in case of wrongful trading. See also, section 218(6) of the Employment Rights Act, 1996; Part 4- Taxation, International and Other Provisions Act, 2010; and Part 3- Finance Act, 2015. Also, see HM Revenue and Customs, Diverted Profits Tax: Interim Guidance, 30 March 2015.

[9] 1987 A.C. 45, 64.

[10] 2013 UKSC 34.

[11] Restricting to these two situations was, however, not consented to by all the judges on bench. For instance, Mance J. stated -“It is …. often dangerous to seek to foreclose all possible future situations which may arise and I would not wish to do so”.