TOPIC: To what extent have the courts recognized that the principle in Salomon v A Salomon may be unfairly exploited? Explain & Illustrate….
It is a feature of a company that a company is not just an association of persons but it has separate legal entity. It is independent and separate from any other entity associated with the company. It is an artificial person in the eye of law. The assets that the company owns are not the assets of its shareholders. The quote relates entirely on the company law of corporate personality, which states that a company is a separate legal entity. A company can sue and on the other hand be sued in the company’s name; it can hold its own property and is actually liable for its own debts. This idea refers to the fact that the shareholders hold limited liability, and therefore, is not liable for the debts that belong to the company.
The case of “Salomon vs. Salomon & Co.  AC 22”, is a case which puts in a good view of how corporate personality and limited liability1 is closely connected to each other. In the case of Salomon vs. A Salomon, because of the formation of a new company Mr. Salomon was no longer liable for the debts of the company. But he became the managing director of the company. It granted himself a secured charge over all the company’s assets. Thus, if the company failed, not only would Mr. Salomon have no liability for the debts of the company, but whatever assets were left would be claimed by him to pay off the company’s debt to him because of the ownership of the debentures, when the company went into liquidation, the owner won was paid off because he has more priority than the other creditors. This is because compared to others debt, his secured debt ranked at a higher priority.2
1Corporate personality refers to the recognition by the state that certain organizations have legal personality. A company once incorporated becomes a separate legal entity or personality and the liability of the members are said to be limited. Limited liability is the logical consequence of the existence of a separate personality.
2See Companies Act 1992 Section 3(1) which provides that subject to Subsection (2) two or more persons may incorporate a company with or without limited liability by signing a memorandum and submitting it to the Registrar of Companies. The logic of separate personality and limited liability was not tested to its full extent until the late nineteenth century as exemplified by the case of Salomon v Salomon & Co. (1897) A C 22.
2.1 Background of Salomon vs. A Salomon & Co. Ltd
Aron Salomon, a sole proprietor, was a successful leather merchant, manufacturing leather boots. He ran his business for a quite a few years and then by 1892 his sons joined hands with him and started working with him. It was then that Salomon decided to turn his business into a Limited company, Salomon & Co. Ltd. As per the legal requirement then, Salomon subscribed seven people as shareholders of the company.
He being the managing director himself, he appointed two of his four sons as directors, and his wife, his daughter and 2 other sons were the other shareholders. Mr. Salomon owned 20,001 of the company’s 20,007 shares – the remaining six were shared individually between the other six shareholders. Mr. Salomon sold his business to the new corporation for almost £39,000, of which £10,000 was a debt to him. Therefore, he became the company’s main shareholder and as well as its principal creditor. But soon afterwards the business did not go according to plan with the leather business and Mr. Salomon sold debentures to save his business. 3
There was a case of insolvent liquidation for the company, i.e. it did not have enough money to pay off its debts and a liquidator had to be appointed, who was a ‘court appointed official’, who would distribute the money owed by debtors by selling off the company’s assets.
3A Two-Edged Sword: Salomon and the Separate Legal Entity Doctrine. (September 2000).
3  AC 22
3 Salomon v A. Salomon & Company, Limited,  2 Ch. 328
2.2 Examining the Dictum
The Court of Appeal agreed with the liquidator and then the House of Lords disapproved the conclusions of the lower courts and put forward some facts. One of them was that the fact that some of the shareholders are only holding shares as a technicality was irrelevant; the registration procedure could be used by an individual to carry on what was in effect a one-man business. The other fact was that when a company is formed with conformity with the rules and regulations of the Companies Act, it is a separate legal entity and not the agent or trustee of its shareholders. Therefore the debts of the company were only its own debts and not those of its members. The shareholders only had a limited liability on the amount of investment they had made on the business.4
This opposing view from the House of Lords now confirmed that the debentures5 rather that shares would further protect investors. In stressing the independent nature of corporate personality, the House of Lords legitimized the practice of the corporate form by individual traders and small partnerships: private enterprises which do not seek to raise capital from the public but are anxious to interject an entity between themselves and their creditors. They came to a conclusion that once a company is registered in the required format of the Companies Act, it’ll form a separate legal entity, even where there is only a bare conformity with the provisions of the Act and where all, or nearly all, of the company’s issued shares are held by one person. Moreover, the court put forward the fact that the shareholders can not only limit their liability on their investment but they can avoid any further risks on it by opting to subscribe for debentures rather than shares.
4 When a corporation undergoes liquidation, the money received by stockholders in lieu of their stock is usually treated as a sale or exchange of the stock resulting in its treatment as a capital gain or loss for Income Tax purposes.
5 Debenture is a type of debt instrument that is not secured by physical asset or collateral. Debentures are backed only by the general creditworthiness and reputation of the issuer. Both corporations and governments frequently issue this type of bond in order to secure capital. Like other types of bonds, debentures are documented in an indenture.
2.3 Piercing the Corporate Veil
In the case of Salomon v A Salomon, according to the House of Lords the company was not an agent of the owner. But Mr. Salomon was the person who was fully controlling the company. So the company can be treated by a business which is carried by a single landlord, not by separate entities. A registered company is a body corporate and legal person separate from the shareholders. The company is at law a different person altogether from the subscribers to the memorandum: and the company is not in law the agent of the subscribers or trustee for them.’ The ‘veil of incorporation’ separates the incorporators from the company; in a group context it operates to make each company in the group a separate legal entity with no liability for the debts or liabilities of other group companies. 6
There are occasions when it seems that the Salomon principle may be unfair, and then the courts are under pressure to review the principle and make decisions contrary to it upon various grounds. This is termed as ‘piercing the corporate veil’. However the courts have not always applied the principal laid down in Solomon v. Solomon & Co. In a number of circumstances, the court will pierce the corporate veil or will ignore the corporate veil to reach the person behind the veil or reveal the true form and character of the concerned company. The rationale behind this is probably that the law will not allow the corporate form to be misused or for the purposes which is set out in the statute. In those circumstances in which the court feels that the corporate forms are being misused it will rip through the corporate veil and expose its true character and nature disregarding the Solomon principal as laid down by the House of Lords. 7
6 Piercing the corporate veil describe a legal decision to treat the rights or duties of a corporation as the rights or liabilities of its shareholders or directors. Usually a corporation is treated as a separate legal person, which is solely responsible for the debts it incurs and the sole beneficiary of the credit it is owed.
7 See HG Henn and JR Alexander, Corporations (3rd edn, Hornbooks 1983) ch 7, 344.
2.4 Criticisms of Salomon v. A Salomon & Co. Ltd (1896),  A.C. 22 (H.L.)
Although still being used in the court, Salomon’s case has faced lot of criticisms. Professor Kahn-Freund described this case as ‘calamitous’. Although it’s of massive importance in company law as it established the independent corporate existence of a registered company, it has got plenty of drawbacks to be precise. It protects parties unreasonably if applied inflexibly, creating a fix among people working in the company as they have to suffer losses because of it. The Law Quarterly Review reported that Salomon’s case was not about “a dry point in construction”. There was a change in ideas about what the company was about, and about the uses to which it could be put, which was sanctioned by the House of Lords. They prioritized the separate identity of the legal form and essentially ignored the economic reality of a one-person company. 8 The criticisms of Salomon’s case are of two-fold:
1. The decision gives even apparently honest incorporators the benefit of limited liability in situations where it is not necessary in order to encourage them to initiate or carry on their trade or business.
2. The opportunities that the decision affords to corrupt promoters of private companies to abuse the advantages that the Corporations Act gives them by achieving a “wafer-thin” incorporation of an undercapitalized company.
When the House of Lords approved the decision in Salomon’s case, each company is seen as a separate legal entity. Added to the consequent attribute of limited liability, Salomon’s principle becomes an active format for fraud. As it can provide protective facilities for the directors and members of the company against claimants such as creditors, it has presented the grounds for fraudulence and other anti-social activities. 9
8 See Cases and Materials in Company Law (7th edition) 2001 (Butterworths): LS Sealy pp 41-75
9 See  13 Law Quarterly Review 6.
If the Salomon’s principle contains more positives than negatives, is a big question mark in itself. It’s too broad a topic to make a conclusive statement on it, but as far as it has been proved is that the principle of separate legal entity has been quite influential in the development of modern capitalism and has generated massive amounts of social and economic wealth. Though some decisions have had negative effects, but they have been neutralized by joint legislative and judiciary actions.
• McGuinness, Kevin, Canadian Business Corporations Law, 2nd Ed. (Toronto: LexisNexis, 2007), pages 34-35
• Griffin, S. (2005). Company law (fundamental principles) 4th edition. Washington, DC.
• Lowry, J., Dignam, A. (2008-2009). Company law
• Salomon v. Salomon & Co. In Wikipedia The free Encyclopedia. Retrieved on November 18 2010, from http://en.wikipedia.org/wiki/Salomon_v._Salomon_&_Co.
• A Two-Edged Sword: Salomon and the Separate Legal Entity Doctrine. (September 2000). Murdoch University Electronic Journal of Law. 7(3).[ Electronic version]. Retrieved on November 20 2010 from http://www.murdoch.edu.au/elaw/issues/v7n3/puig73a_text.html#Conclusion_T.
• Company Law (Longman) 2001: Ben Pettet pp 25-30
• Salomon v A. Salomon & Company, Limited,  2 Ch. 328
• Duhaime, Lloyd, Timetable of World Legal History
• Pennington’s Company Law (8th edition) 2001 (Butterworths): Professor Pennington pp 36-60
• Salomon v A. Salomon & Company, Limited, 1897 A.C. 22
• Cases and Materials in Company Law (7th edition) 2001 (Butterworths): LS Sealy pp 41-75
• Practical Company Law (Volume 1) 1998 (Sweet & Maxwell): Mark Stamp pp1-3