This is a UK landmark case on the doctrine of corporate personality which gives a company a legal distinct entity from its shareholders. This case is commonly known as Salomon v Salomon.
Facts of the Case
Mr. Aron Salomon, the respondent was a boot and shoe manufacturer. He initially run his business as a sole proprietor. He had been trading for over thirty years and he had gradually built up a thriving business. On 28 July 1892, the respondent company, was incorporated with a capital of 40,000£ divided into 40,000 shares of 1£ each. The company was formed to take over the appellant’s business. The memorandum of association of the company was subscribed by the appellant, his wife and daughter, and his four sons, each subscribing for 1 share. Two of his elder sons were appointed as directors. Through an agreement dated 2 August 1892, the company took over the business from the appellant. In return, appellant received 20,000 paid-up shares, a sum of 10,000£ paid in debentures having a floating charge on the company’s assets and about 1,000£ in cash from the company.
Shortly after the company took over the business, there is a decline of sales in the boot and shoe trade. The appellant had cancelled and reissued half of his debentures to a Mr. Broderip, who advanced him 5000£. Mr. Broderip's interest was not paid when it became due. He took proceedings at once and got a receiver appointed. Then, of course, came liquidation and a forced sale of the company's assets. They realized enough to pay Mr. Broderip, but not enough to pay the debentures in full and the unsecured creditors recovered nothing. This is because the debentures held by Mr. Broderip and the appellant stood prior to the claims of the unsecured creditors. The liquidator on behalf of the unsecured creditors alleged that the company was sham, was essentially an agent of the appellant, and therefore, Salomon being the principal, was personally liable for its debt.
At the Trial, the Court held that the business belongs to Salomon and he chose to employ the company as his agent. Thus, Salomon is bound to indemnify that agent. Salomon appealed to the Court of Appeal but his appeal was rejected. The Court of Appeal held that that the company was a scheme to enable Salomon carry on business in the name of the company. It was held that the company was made against the true intent of CA 1862 hence was trustee of Mr Salomon who should be made liable to pay costs of carrying out the trust. Salomon then appealed to the House of Lords.
Issue of the Case
Whether the respondent company was validly constituted?
Whether the appellant was personally liable for the company’s debt?
Judgment of the Case
Section 6 of the Companies Act 1862 provides that any seven or more persons, associated for a lawful purpose, such as the manufacture and sale of boots, may, by subscribing their names to a memorandum of association and otherwise complying with the provisions of the Act in respect of registration, form a company with or without limited liability. Section 8 provides that in the case of a company limited by shares, a subscriber shall take at least 1 share.
The House of Lords states that the provisions do not require that the persons subscribing shall not be related to each other and there is no rule imposing any limit upon the number of shares a single member may subscribe. It is found that the respondent company was formed in compliance with the provisions of the Companies act and thus it is an independent person with rights and liabilities of its own.
One of the arguments raised is that the respondent company is a “one man companies” which suggest that a company under the absolute control of one person is not a company legally incorporated. The Court rejected this argument and states that it merely means that there is a key partner possessing an overwhelming influence and is entitled to most of the profits but this type of company is not contrary to the intention of the Companies Act, against public policy or detrimental to the interests of the creditors.
It was also argued that the agreement to transfer the business from the appellant to the respondent ought to be set aside because there were no independent boards of directors and the property was transferred at an overvalue. The court held that the directors did just what they were authorized to do by the memorandum of association and there was no fraud or misrepresentation.
Hence, the appellant is not personally liable for the company’s debt as the company was validly constituted.
Principle of the Case
A company duly incorporated has a legal personality separate and independent from the identity of its shareholders. This enables the company to own property, execute contracts, raise debt, make investments, sue and be sued on its own name. The shareholders of a limited liability company are only responsible to the extent of their capital contributions.
The full judgment can be accessed here.
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