Salomon v. Salomon & Co. Ltd.

 

Salomon v. Salomon & Co. Ltd.

This case analysis of Salomon v. Salomon & Co. Ltd. is a landmark one that upholds the real spirit of the Companies Act and establishes an essential concept that a corporation has a separate legal person and its corporate veil should not be breached.

This idea is recognised as the cornerstone of the system of international business law as well as English company law. In this case, the House of Lords ruled that because a corporation has a separate legal identity, the shareholders cannot be held personally accountable for the company's losses at the time of liquidation.

In the viewpoint of the law, a corporation is a legal person. It is viewed as a manufactured human. Because a corporation is distinct from and independent of its members, the members are not responsible for the Company's actions. As a result, even if a shareholder owns the majority of the company's shares, he is exempt from liability for the company's actions.

Facts of the case
Aron Salomon, the appellant, operated as a wholesale boot maker and leather trader. He designed the transfer of his firm to a joint stock company, the regulations of which were to be set down by the Companies Act 1862, in order to reduce his liability. On July 20, 1892, the appellant and Adolph Anholt, who was acting as the trustee of the future firm, entered into a preliminary agreement to determine the conditions of the transfer of the business, one of which provided for part payment to the appellant in terms of debentures.

When it was sold to the joint stock company, the appellant's firm was completely stable and sound financially. Thus, the vendor/appellant and his six other family members—his wife, his daughter, and his four sons—formed the only members of the corporation. The resulting limited corporation had 40000 shares with a face value of one pound apiece as permitted capital. Only 20007 shares were issued and subscribed out of these total shares, 20001 of which were held by the vendor (appellant), and the remaining 6 shares were held by each member of his family.

The family members were aware of and properly consented to all the terms of the deal. In addition to the appellant's subscription of 20001 shares, he also received 10,000 debentures as floating security as part of the share purchase money.

The preliminary agreement of July 20, 1892, and its terms and conditions were realised in accordance with the terms of the Memorandum of Association, which was also properly completed. After all necessary legal procedures were completed and the MoA had been properly registered, the business was officially established as "Aron Salomon and Company, Limited."

The vendor was able to outvote other family members because to the vast quantity of shares he owned. Additionally, he was chosen to serve as the company's managing director. These factors together caused the concentration of power in his hands. However, all of the conditions of the Companies Act of 1862 have been lawfully met as of this point.

Out of the total number of debentures granted to the appellant, he utilised 100 of them as collateral to get a 5000-pound advance from a Mr. Edmund Broderip. However, new debentures were subsequently granted to Mr. Broderip at 8% interest due to an error in the allocation of debentures to the appellant.

Unfortunately, the appellant's joint stock company went bankrupt and failed to pay interest on its debentures to Mr. Broderip, who then filed a lawsuit to assert his security claim against the firm's assets. In order to collect the debt out of the aforementioned assets, a liquidation order was subsequently passed and a liquidator was chosen at the request of the other unsecured creditors.

It was realised that after paying out the debt and interest on Mr. Broderip's debentures with the proceeds from the sale of assets, there would still be 1055 pounds, which would have to be utilised to pay up the appellant's debenture obligation. According to the Companies Act, the other creditors' financial claims could only be satisfied once the debenture holders' claims had been satisfied.

The severe lack of finances for the fulfilment of the unsecured creditors' financial demands, which totaled a staggering amount of 7733 pounds, caused the creditors' distress. Mr. Broderip received payment. However, the liquidation (on behalf of the corporation) wanted to pay off the creditors without fulfilling the appellant's debenture debt, which is why the appellant sued the liquidator. The liquidator was nominated by the other creditors (the company).

The appellant sued the business in the trial court, arguing that his joint stock company had been properly registered and incorporated in accordance with the Companies Act and that the claims of secured debenture holders should be honoured before those of unsecured creditors. In a counterclaim filed on behalf of the company against the appellant, the liquidator alleged fraud against the business and creditors and asked for the cancellation of the agreement dated July 20, 1892, as well as the appellant's assigned debentures.

The trial court denied the firm's request for relief and noted that, although being properly constituted as a limited company, the company had been acting as the appellant's agent while conducting the appellant's business. The appellant was required to hold the firm harmless to the amount of the creditor's claim because the corporation served as only his agent. Given the trial court's ruling, both parties submitted an appeal.

Judges Lindley L.J., Lopes L.J., and Kay L.J. made up the three-judge bench of the appellate court, which decided the case on May 28, 1895. They determined that the company's founding was a myth or fabrication and that Aron Salomon owned the real corporation. He used the other six members, who were also shareholders in the company, as a ruse to manage the company with limited responsibility, which was against the genuine objective of the Companies Act of 1862.

By placing a first charge on the assets, the appellant made the decision to purchase the debentures in order to give himself priority over the claims of other creditors. As a result, the appellant was responsible for paying the unsecured creditors.

The appellant brought the current lawsuit after being upset with the appellate court's ruling.

Issues Stated

1.   Whether there was a valid constitution of a joint stock company?

2.   Whether the company was defrauded by the appellant?

3.   Whether the unsecured creditors were defrauded by the appellant?

Appellants Contention

The appellant argued that if the business met all legislative criteria, it should be considered as a separate legal entity. The requirements of the Companies Act were faithfully followed both during the company's creation and afterward, ensuring the validity of the joint stock company's constitution. The goal behind the company's creation was also legitimate.

If the Company's formation was legitimate, all of the Company's transactions, including the appellant's debenture allocation, were valid as well. It was argued that it didn't really matter whether the debentures were owned by the appellant or any other creditor for that matter with regard to the appellant's holding of them via the arrangement dated 20 July. A priority in payment over the other creditors was all that counted.

According to the Companies Act of 1862, in order to qualify as a shareholder, an individual must own one share, and their relationship to other shareholders need not be significant. In light of the foregoing, the appellate court lacked the authority to apply restrictions that ran counter to the aforementioned norm and invalidate the company's formation.

The sale of the company was made with the sincere goal of limiting responsibility rather than to shift the appellant's growing losses to third parties. At the time of the transaction, the company was real, solvent, and growing. As a result, the appellant did not cheat the corporation.

Additionally, the family members' agreement to participate as shareholders was sincere and legal because they offered it only after thoroughly understanding all the terms and circumstances.

Regarding the conversion of the appellant's company into a limited company, it was argued that there was nothing improper with turning a private company with unlimited liability into a joint stock company with limited liability because banks and other businesses regularly engage in this activity.

Furthermore, it was argued that the creditors had not been misled or given false information. The shareholders and holders of the company's debentures might be contacted by the creditors to learn more about their ownership interests in the company's shares and debentures, respectively.

Respondent Contention
Despite being constituted under the Companies Act, the respondent argued that the business was improperly formed since it never had any independent existence. The appellant served as the company's managing director and had complete control over it. His family members only served as props and helped the appellant's goals. They lacked independent minds and wills, and the appellant served as their only ruler. Accordingly, the firm was a fake and operated as the respondent's alias, which is against the letter of the Companies Act.
The main goal of the appellant was to shift the blame for the company' losses onto third people because it was in a precarious condition when it was sold to the Company. The appellant planned to cheat the firm and creditors by transferring the business risk to the creditors so that he could do it without hindrance or danger.

Additionally, the appellant shrewdly used the debentures to evade the company's obligation and shelf off the losses. Furthermore, the appellant knowingly kept the existence of the debentures from the creditors.

The business was overvalued by the appellant in order to get the extortionate amount of purchase money, which resulted in the firm being cheated. The conditions of the business transaction were wholly determined by the vendor, which was exploitative per se.

Decision

The court overturned the appeal court's decision and determined that the corporation was not the appellant's agent. The House of Lords ruled that the Company had been legitimately established and in accordance with the requirements of the Companies Act. Given the company's legal status, all of its transactions, including the appellant's debenture allotment and the agreement dated 20 July 1892, were genuine. Given their limited culpability and the fact that the firm was a distinct legal entity (SLP), the stockholders shall not be held personally accountable for the creditors' claims in the current liquidation. They would only be responsible for the value of the shares they had subscribed for.

Since the shareholders were aware of the price and other terms and conditions of the transaction, the court determined that the appellant's sale of his boot and leather business to the limited liability company was lawful and that the amount paid as a result of that sale was not excessive. Following proper shareholder approval, the selling transaction was completed. As a result, the appellant cannot be charged with fraud.

The fact that the company's shareholders included the appellant and his six other family members, each of whom owned one share, did not affect the company's eligibility under the Companies Act because it was not necessary to have a relationship with another shareholder to qualify as a shareholder under the law. Additionally, the Act did not specify the amount of interest or influence that each shareholder was to exert in proportion to their ownership of shares. Therefore, it was acceptable for the appellant to function as the Company's MD and to have more influence over other members of his family who were stockholders in this instance.

It was decided that even though Aron Salomon decided to use a corporation to run his business, there was nothing improper in doing so when considered in light of the real object and meaning of the Companies Act. The promoters' intentions or actions were wholly unimportant in the specific situation when the firm was lawfully constituted. The resulting corporation should be regarded as an autonomous entity with its own rights and obligations.

The Act allowed for the formation of a corporation by the association of seven or more separate, autonomous, bona fide members who had their own free will and mind. In the cited instance, the shareholders worked together voluntarily to protect their group interests, and they were all aware of and in agreement with the terms of the transaction. The shareholders took a lawful action by transferring their profitable firm to a limited liability corporation in order to restrict their exposure. Therefore, there was no way to prove that the appellant had committed fraud. This claim was made after considering the Erlanger v. New Sombrero Phosphate Co. case.

The Companies Act gave the unsecured creditors complete latitude to examine and evaluate the company's share and debenture holdings, so they were not misled. The law had no obligation to inform the creditors that they would not get payment as a result of the company's poor performance. The law had no obligation to inform the creditors that they would not get payment as a result of the company's poor performance. They behaved negligently by failing to assert their rights and becoming aware of the terms of the company's purchase.

Ratio Decidendi

Once the corporation was formally formed, it became a separate and independent legal entity. Therefore, it is best to avoid piercing the corporate veil. As a result, the shareholders in such situations cannot be held responsible for paying any amount beyond their part of the subscribed shares. In other words, since the Companies Act caps the liability, they cannot be held personally accountable for the indefinite obligations.

According to the Companies Act of 1862, one share was all that was required to qualify as a shareholder. Neither the relationship between the shareholders nor the power or influence they wielded in any way affected their standing as shareholders. The six more appellant family members were legal owners despite acting like simpletons because they each owned one share, thus this didn't matter. As a result, all of a company's transactions were legitimate and lawful in and of itself once it had been properly formed.

Conclusion

The business environment was altered by this important case. It thoroughly built and emphasised the Joint Stock Companies' fake individuality. It said that the corporate veil cannot be simply destroyed in order to jeopardise the shareholders' interests. Once incorporated, the business existed independently of its founders and stockholders in a legal sense. This opened the door for a fresh revolution in shareholder rights inside the corporate setting.