Applicability of Salomon Principle in the Company Law - Essay Example

?Company Law Table of Contents Table of Contents 2 Introduction 3 Solomon Principle and Tort Creditors of a Subsidiary Company 4 The Viewpoints of English Courts in relation to Flexibility of Salomon Principle for Tort Creditors 9 Conclusion 12 References 14 Introduction ‘Salomon v A Salomon & Co Ltd [1897] AC 22’ is widely regarded as a milestone example of the UK corporation law cases. It is particularly owing to the fact that the extension of the case led to the foundation of the Salomon principles in relation to Company Law related statutes. The principle, in simple terms, implies that the company has been legally incorporated and accordingly it should be considered as an independent person with certain specific rights along with liabilities to guide its operations. It implies that if somebody starts a business as a limited liability company, the company is regarded as a legal entity with a separate legal personality, which signifies that a company is different from its owners, employees along with shareholders. This in turn assures the advantages of ‘corporate veil’ to the company, wherein the owners, employees and shareholders are directly charged with the damage claims or tort claims caused due to their misconduct or irresponsible conduct with the name of the company. The Salomon principle in this regard emphasises that a company only provides grounds for individuals to act in its behalf and thus, charges in lieu of the tort laws should be treated in a way that makes the decision makers directly, personally and professionally liable for the damages1. In this regard, it has often been argued and has subsequently been under stern arguments that the tort creditors of a subsidiary company holding limited liability shall be deemed as ineligible to obtain the benefits from Salomon principle. It is worth mentioning in this context that because tort creditors are also recognised as involuntary creditors and fall into the classification of unsecured stakeholders2. The case rule in Adams v Cape Industries plc plays an influential role in this context wherein it affirms that employees of subsidiary companies, as involuntary creditors and also as tort creditors should be considered as eligible to demand damage compensations from the parent company. In is in this context that the application of Salomon principle is regarded as unjust in respect to the tort creditors where the parent company bears a rational degree of ‘duty of care’ to protect the interests of its subsidiary tort creditors3. Emphasising this particular issue, the discussion henceforth intends to discuss about the applicability of Salomon principle in the company law. Moreover, the discussion will also emphasize on the various aspects on the basis of which Salomon principle is regarded to be unfair for tort creditors of a subsidiary company. Solomon Principle and Tort Creditors of a Subsidiary Company As mentioned above, the Salomon principle has been developed from the case ‘Salomon v Salomon & Co, Ltd’. The Salomon principle implies that corporate decision makers should be legally entitled to compensate the damages suffered by the stakeholders of the business due to their misconducts or ignorance to ‘duty of care’, as per the relevant tort law. These companies are regarded as private and should be registered under the Companies Act 1862. In this regard, a registered company is determined to possess a separate legal entity as per the Salomon principle, which differentiates the statue of such a company from its shareholders, employees and other individuals associated with it. In this context, a company incorporated under the Companies Act 1862 is treated as an independent individual possessing its own respective rights along with liabilities that are different from the rights and liabilities owned by its decision makers, which further justifies the application of corporate veil in segregating the liabilities of individuals from that of the company as separate entities. There are various instances where the principle of Salomon has been identified to be applied in order to resolve problems between creditors and a company, securing the interests of both the parties. In this regard, a company with limited liability is seemed to pose challenges to tort creditors and other involuntary creditors to recover their debts, considering them as ineligible for such benefits at common instances, to which, the Adams v. Cape Industries Plc case postulates an exception to the principle4. For instance, in the case of Macaura v Northern Assurance Co. [1925] AC 619, it was identified that a corporate sector, which is registered and holds a separate legal entity should be recognised as an independent individual irrespective of the presence of shareholders and other members associated with it5. Another case of Lee v Lee’s Air Farming [1961] AC 12 signified that legally registered company is a separate legal entity and can enter into contractual agreements with others. Additionally, the company is determined as the sole proprietor and others involved with it as workers that may not directly, but indirectly agrees to the regime of not applying Salomon principle for the employees of subsidiaries as tort creditors6. Conceptually, a subsidiary company is a corporate entity whose shares are completely or particularly acquired by the parent company, which makes the parent company liable for the tort damages incurred by the employees of subsidiaries under the similar regime of Salomon principle. In a subsidiary company, the business operations and management functions are coordinated by the parent company. In this regard, a subsidiary company with limited liability implies that the investments made by shareholders are statutorily limited with regard to their obligations in case of bankruptcy or liquidation. Additionally, the context of limited liability assists investors in making investments in risky business enterprises as they are entitled and liable to the invested amount from the company in case of liquidation or bankruptcy. In case of bankruptcy or liquidation, the creditors and shareholders of a company are liable to receive their debts and invested amount, which further contradicts the application of Salomon principle when involving tort creditors7. Creditors associated with a company are identifiable into two classifications, viz., voluntary and involuntary creditors. The voluntary creditors are facilitated with the opportunity of having their debts before other creditors. Consequently, involuntary creditors are the individuals investing in a company with a priority of receiving their debts after voluntary creditors as in the case of employees. In this regard, the provision of limited liability ensures that creditors of a company are prioritised on the basis of privileges. Accordingly, the voluntary creditors are protected under the Company Law provisions, which imply that in case of bankruptcy and other related incidents in relation to shrinkage of company’s funds and assets, they are the first to be compensated. Subsequently, the debts are paid to the creditors by the shareholders who are assigned with the task of making the payment. On the other hand, the involuntary creditors are also recognised as tort creditors are commonly deemed to be unprotected under such statutory measures. Tort creditors are liable for compensation after voluntary creditors. The torts creditors are not provided with the opportunity of bargaining for the debts and compensations like the voluntary creditors. In this regard, it can be ascertained that voluntary creditors may demand for their compensation in contrast to tort creditors in case of limited liability8;9. In simple words, tort creditors are referred to those individuals involved with the operations of a company, such as employees. In case of a company with limited liability, the tort creditors are offered with minimum priority as compared to other creditors during bankruptcy. It is identified that tort creditors are the involuntary creditors and are considered after secured or voluntary creditors during wind-up. The tort creditors are prioritised after secured creditors due to the factor that prioritising tort creditors over the secured creditors will shift the level of investment risks towards voluntary or secured creditors. In this regard, during bankruptcy, the tort creditors are the ones who are often found to suffer greater damages10. The tort creditors are treated with different priorities as compared to other creditors due to the differences in the legal relationship developed between creditors and a company. The tort creditors are the ones who do not possess a legal relationship with the corporate entity. The employees of a company is therefore identified to be tort creditors who are unable to protect themselves as other creditors during bankruptcy and insolvency of a corporate sector. In Rogers AJA in Briggs v James Hardie & Co Pty Ltd (1989) it was identified that the Salomon principle provides the rights to business to limit the liability of individuals entrusted with the operational activities and on the other hand obtaining investments from outside investors, which morally seems to be an injustice to tort creditors of subsidiary companies11. In this regard, it can be ascertained that corporate entity prioritized different individuals with different rights. The tort creditors of a subsidiary company thus have to face challenges in getting compensated when there is a shortage of assets and funds. Additionally, the shareholders of the dependent companies are natural persons or companies. The holding or parent company is not provided with any incentive from the subsidiary company with the intention of minimising liability on the claims that may arise from the subsidiary company thereon. Accordingly, the subsidiary company may avail adequate funds in order to meet the claims its creditors12. Thus, it can be comprehended from the above discussion that a corporate legal entity treats different creditors with varying priority on the basis of which, the creditors are compensated in case of company wind-up. The tort creditors are the prime individuals facing ample challenges in having their claims to be compensated in a subsidiary company as they are considered secondary in the priority list, after voluntary creditors. The Viewpoints of English Courts in relation to Flexibility of Salomon Principle for Tort Creditors The English Courts have argues that the tort creditors should not be treated with flexibility in relation to Salomon Principle as the English law do not fully recognise the concept of the corporate veil. The courts do not consider the principle of corporate personality as an important principle under the company law. The concept of legal personality, i.e. separate legal entity, signifies that a company is distinct for the members who are associated with it. As mentioned above, this principle is commonly attributed as the Salomon principle that came into recognition after the case of ‘Salomon v Salomon & Co Ltd’. The courts in order to minimise the issues attached with the insolvencies of different corporate groups have adopted a better assertive method on the basis of which, the corporate groups are directed to be used as a measure to thwart the duties of directors towards the creditors. The courts also signified that the principle of separate legal entity will be honoured in the UK Company Law but shall follow an exception when treating tort creditors under the Salomon principle. However, the aforementioned Salomon principle can be disregarded in case of any compelling reason. As in the case of Industrial Equity Ltd v Blackburn, Mason J stated that a corporate legal entity should be contractually associated in order to deny the principle of separate legal entity13. It implies that without any mutual contract between the parent and subsidiary company, the liability of the subsidiary company cannot be transferred to the parent company. In this regard, the debts and claims of tort creditors of the subsidiary company should be settled in the respective subsidiary company, wherein the parent company will not be liable for the payment of debts of creditors14. The courts also revealed that there are certain incidents on the basis of which, the parent company will be liable for making the payment of debts of creditors of a subsidiary company in case of fraud, single economic entity and agency. In this context, the English courts were of the view that it will lift the incorporate veil during instances, where a parent company is identified to be involved with different fraudulent practices in relation to operations along with development of its subsidiary company. The liability of the creditors will fall on the shoulder of the parent company subsequently. In contrast, if there are no fraud practices conducted by the subsidiary company, the liability of the creditors will be compensated by any respective company15. The case in Pioneer Concrete Services Ltd v Yelnah Pty Ltd. also signified that every corporate should be identified as a separate legal entity but in certain fraudulent cases the corporate veil can be lifted with the aim of evaluating the mechanism of their operations, especially when involving employees as tort creditors16. Moreover, the English courts have stated that when a parent and subsidiary company develop an agency relationship, the parent or holding company will be liable to compensate the debts of its subsidiary company. There are six important factors identified from Smith Stone & Knight Ltd V Birmingham Corporation in this regard, stating the incidences where a corporate entity is determined to be under agency relationship17. The six factors are stated as below: The profit of the subsidiary company are transferred to the parent company The management of the subsidiary company is selected by the parent company The parent company devises strategies for the trading operations of subsidiary company The parent company ascertains the trade ventures and capital management operations The profits generated with the activities and competencies of the management of parent company The operations of the subsidiary company are in constant regulation under the parent company Source:18 The aforementioned six factors provide the basic points on the basis of which the relationship amid parent and subsidiary companies is determined in the English courts. In Adams v Cape Industries plc, it was accordingly identified to follow the rule, which implied that the parent company will not be liable for paying the compensation of the tort creditors as there was no agency relationship between the parent and the subsidiary company. Additionally, the subsidiary company was classified as facade, which implied that the company was incorporated for illegitimate purposes, which in turn made the owners or decision makers of the parent company liable for the tort damages as per the Salomon principle19. Conclusion In accordance, the Salomon principle states that any company under registration with Companies Act will be identified as a separate legal entity signifying that the company will be treated as a different independent legal entity from the members associated with it. It is also recognised that the creditors of the company are prioritised on the basis of their rights, which according to English courts tend to cause an injustice to tort creditors of subsidiary companies. In this regard, the English courts have signified that the operations of the parent and the subsidiary companies cannot be recognised as a single economic entity in relation to different factors, which include organisational goals as well as objectives and operations. Thus, it can be identified that the courts have neglected to develop flexibility in the application of the Salomon principle in relation to tort creditors as it increases the complexity of determining the relationship and association between the parent company and the subsidiary company. In this regard, the increased complexity raises difficulties in ascertaining the corporate entity as liable for compensating the tort creditors and other creditors20. Therefore, in accordance with the above discussion, it can be affirmed that the statement, ‘As for tort creditors of a subsidiary company, it is often argued that the application of the Salomon principle is particularly unfair in their case’ is true21. 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