The Rationale and Impact of the Rule in Salomon versus Salomon - Essay Example

THE RATIONALE AND IMPACT OF THE RULE IN SALOMON V SALOMON & CO [1897] AC 22 ON COMPANY LAW Introduction The Salomon decision of 1897 is the core decision that established and confirmed the doctrine of the separation of corporate individuality of an included organisation or company. Since then, the doctrine of separation of official personality attained upon the establishment of a company has been the character of the law governing companies. However, the concept of allowing a company to acquire legal personality was not a creation of the English but had its origin from the Roman laws. Nevertheless, the decision of the House of Lords in the Salomon case was very significant in building strong attitudes in favour for the acceptance of the principle of legal personality for companies. This article will examine the rationale of the decision and its impacts towards the development of company law. Rationale of the rule The status of limited liability went to specific companies before 1825 through the provisions of express available in the Royal Charter regarding Incorporation. Section 2 of the Bubble Act of 1825 governed the first efforts in officially, introducing the concept of limited liability to the English laws. The section provided that the shareholders of a particular corporation would personally be liable in their own persons as well as their property to that extent as well as subject to the regulations and limitations as his magnificence. Although there was no opposition from the Crown to the idea of legal personality, public pressure turned in opposing any extension of legal personality that later became troubled with the stance of creditors. This provoked public suspicions because of the expectation that the Bubble Act would lead to an increase in the number of licensed companies with limited liability. This therefore was the reason for the withholding of the doctrine of limited liability from Company Act in 1844 (Ferran 1999). However, public opinion moved in the reverse direction in favour of the principle of limited liability. In the 1850s, the doctrine acquired recognition in the law. In the year 1852, the Court of Exchequer chamber in the case of Hallet versus Dowdall accredited the legality of the clause of limited liability of 1952. This in turn prompted the parliament to pass the Limited Liability Act in 1855 as well as more contemporary act of Joint Stock Companies of 1856. Consequently, this led to the enactment of the Companies Act in 1862, which formed the foundation for the delivery of the rule in Salomon. The intention of the House of Lords in the Salomon rule was to send a clear message to the members of the public and endorse the doctrines of legal body as well as that of limited legal responsibility (Ferran 1999). The beginning of the Salomon case was where Vaughan embraced the idea that the company was simply a contender or an agent of Mr. Salomon. This obviously, was a wrong interpretation of the law. In addition, the Appeal Court came up with an incorrect idea when it stated that the establishment of a company and the issuance of debentures were a plain plot to allow Mr. Salomon to conduct business activities using the company name with a limited liability opposite to the real intention of the Companies Act of 1862. All these wrong interpretations of the law came because of the condition adjoining the concept of limited liability during that time and the desire for the courts to reinstate fairness as well as indemnifying the creditors who lacked security (Ferran 1999). The House of Lords, having the mandate of giving the final decision for the case, revoked both of the two erroneous decisions hence clarifying that the doctrine of separation of legal personality as well as that of limited liability had obtained full permission from the Companies Act of 1862 and in the common law. In addition, the House of Lords discarded any proposition of fraud, caricature or deception possible of accrediting Salomon because he is an individual who properly, accomplished all the requirements of the state when he was establishing the company. This therefore led to the upholding of the separate legal body of the company and became the foundation for the autonomy of the corporate individuality. Lord McNaughton pointed that the company, according to the law of the land, is a completely different individual collectively right from the memo to the subscribers. This is irrespective whether upon incorporation, the business remains the same as before and the same individuals become the managers while receiving the profits earned by the company. According to Lord McNaughton, the company is by the law neither an agent to the subscribers nor their trustee. He added that the subscribers are not liable members in any form apart from the level and the way stipulated in the act (Ferran 1999). This followed the rejection of the distorted ideas of the lower courts since the desire to extensively, seek for justice or fairness cannot give permission to deviate from the laws of the state. As a result, the superseding desire of enhancing business activities and growth of the economy gained favour during the time because of the priority over both the extensive as well as the self-satisfactory use of the concepts of justice and evenhandedness. The decision clarified the necessity of availability of adequate information concerning the performance of the company to creditors before arriving at the decision of whether or not they can invest their money in the company. It called for the necessity of government to come up with measures to safeguard investments and deal with irresponsible behaviour (Ferran 1999). The Salomon case therefore influenced the parliament to enact the Companies Act in 1900 that asked for the registration of public charges on the property owned by the company. The Company Act of 1907 also allowed liquidators to escape floating charges provided for securing already existing debts. The evidence in the case of Salomon indicate that Salomon business, prior to transferring to the new company had performed well and produced enough profits for Salomon to cater for himself as well as the family. According to the decision arrived by the House of Lords in Salomon case, a company has a separate personality recognized by the law in that a property of the company will remain a property of the company. The debt of a company will remain a debt of the company. Companies can also engage in contracts with their members, managers as well as outsiders and the company is capable of committing crimes and torts (Ferran 1999). Cases where the Salomon case influenced Decision The view that the property of a company remains the property of the company applied in the case of Macaura versus Northern Assurance Company. The appellant, Mr. Macaura claimed for the imbursement of insurance for his own company. However, all the insurers refused his request claiming that Mr. Macaura had no insurable interest because the buying of the insurance based on Macaura’s name as opposed to the name of the company. The court upheld the decision of the insuring company and concluded that Macaura, despite owning all the shares of the company, he himself is not the company and no any creditor owned any property belonging to the company (Ferran 1999). The idea that the debt of a company remains for the company found useful application in the case of Lee versus Lee’s Air Farming limited. Mr. Lee established a company by the name Lee’s Air Farming limited where he was the key shareholder as well as the executive director of the company. Mr. Lee was working for the company while receiving wages after the company sealed contracts with farmers to conduct topdressing by air. Mr. Lee died in an accident prompting his wife, Mrs. Lee to claim for compensation based on the policy stipulated in an agreement between Mr. Lee and an insurance company. The insurance company refused to give compensation claiming that Mr. Lee could not be a worker to his own company. However, the court upheld Mrs. Lee’s claims and rejected the argument presented by the insurance company. Lord Morris, referring to Lord Halsbury judgment in the case of Salomon stated that the company though owned by Mr. Lee was a real person and hence capable of employing Mr. Lee. Evaluation of the Decision in Salomon Case The principle of legal entity has set the trial of the time because the company has acquired a practical significance. Being a separate person, receiving recognition by the law through the doctrine of limited liability characterised by the transferability of shares, permanent existence, specialisation of management, flexible methods of financing, the rule of the majority plus the other features have enabled the company to acquire many advantageous functions both financially as well as socially (Parkinson 1995). Firstly, the principle of separate legal entity has enabled the public to invest and share the profits earned by a company without participating in the management of the company. The company is capable of hiring professional managers to manage the business in the most efficient manner resulting to increased profits. In addition, as an individual constituted by the law, the company is capable of existing forever without worrying about any biological death of its shareholders. The company can thus exist continuously while moving on from one generation to another. In addition, the doctrine has reduced the risk of investment since the investors are simply dependable to the share that they have subscribed for. The Salomon rule aimed at paving the way for a company to collect large sums of money to carryout business effectively and give investors a significant confidence thereby promoting investment and economic growth (Parkinson 1995). Impacts of the Salomon rule on company law The Salomon rule continued to be the law governing companies in the courts of all countries that share similar interests with Britain. The rule formed the foundation through which all the other laws regulating the operation of companies including the piercing of the veil principle developed. The doctrine established that the company activities lie in the hands of the company itself rather than the shareholders. The shareholders are therefore not liable for the debts of the company above their original investment in their capital and they do not have any proprietary concern in the assets owned by the company (Ireland, Grigg-Spall & Kelly 1987). Piercing the corporate veil, a derivative of the Salomon principle, refers to the idea of the court to disregard the existence of the company for failure by the shareholders to meet either one or some of the legal requirements as well as the formalities. The idea of lifting the corporate veil is not a judicial act and therefore its meaning comes from judges. Lifting the corporate veil means having a regard to the shareholders of the company for a legal objective. Despite the fact that each company, upon formation acquires a separate personality recognised by the law, the courts may sometimes pierce the veil to the true controllers of the company (Payne 1997). Conclusively, the piercing veil principle is the opposite of the concept of limited liability established by the Salomon rule. The development of this principle aimed at addressing the weakness of the Salomon doctrine in protecting the rights of creditors. Piercing of the veil therefore means that the personal assets of the shareholders see their exposure to litigation in the case the business had been either a general partnership or a sole proprietorship business. The courts of the common law have the exhaustion or special jurisdiction of lifting or looking beyond the veil at any moment they wish to scrutinise the mechanism of operation of a company. This wide gap of intervention given by the judges of the common law has made the principle of piercing the veil to become among the major litigation issues in the company law (Payne 1997). In the case of Briggs versus Hardie & Co Pty, Rogers AJA stated that there is no universal and unifying doctrine, which underlies the sporadic decision of courts to disregard the corporate entity. Despite the fact that an unplanned explanation can be available from the court, there is lack of a principled means of deriving it from the authority. Therefore, the major problem with the Salomon rule was not the disagreement for the separation of legal personality. The problem was the failure by the House of Lords to provide guidance on what the courts must consider in the application of the principle of corporate legality and the conditions under which one can reject the enforcement of the contracts linked with the structure of the company (Payne 1997). Nevertheless, before disregarding the corporate entity, judges consider various considerations, which include fraud, agency, unfairness and sham. This is because; the courts tend to preserve the Salomon doctrine to the highest degree possible. Fraud comes in when the shareholders of a company use it as a way of evading obligations provided by the law. This is when the owner of the company uses fraud to deny creditors of the company their original rights provided by the law. The court can also disregard the principle of corporate entity when there is good evidence of unfairness on the side of the company under consideration. The court can decide to pierce the veil if the court finds that doing so will help bring fairness for the plaintiff (Payne 1997). The doctrine of disregarding the corporate entity is currently in a state of transition in most jurisdictions of common law. The recent practice by the courts indicates that they are becoming more interested with both the legal as well as the equitable doctrines with the aim of dealing with the emergence of fraud. In short, what common law considers most is justice as well as propriety? This means that the only reason for piercing the veil by the court is to restore equity. However, the requirement of fraud remains very important in the jurisdiction of the common law. The major objective is to control the undesirable conduct of the shareholder and connect with the damage suffered by the plaintiff (Nyombi 2014). Conclusion The House of Lords in the case of Salomon applied the most appropriate law regarding the facts presented during the case. The Companies Act of 1862 provided for the principle of separation of legal body as well as that of limited liability. Piercing the veil in the various circumstances will lead to a twist in the words of the legislation as well as ignoring the unfavorable results upon the activities of the company. This will lead to slow growth in the economy and when magnified it can affect the global economy. The court should not therefore pierce the veil in cases where a statutory base for the decision does not exist. While addressing the emerging issues in the modern societies, it is not desirable to move too far to seek for justice for the various stakeholders while ignoring the constraints placed on the business by the world market.   Bibliography Canfield, George F. 1917, ‘The scope and limits of the corporate entity theory’, Columbia Law Review, Vol 17, pp. 128-143. Ireland, Paddy, Ian Grigg-Spall, and Dave Kelly 1987, ‘The conceptual foundations of modern company law’, Journal of Law and Society, Vol 14, no 1, pp. 149-165. Nyombi, Chrispas 2014, ‘Lifting the veil of incorporation under common law and statute’ International Journal of Law and Management, Vol. 56, no. 1, pp. 66-81. Payne, Jennifer 1997, ‘Lifting the Corporate Veil: A reassessment of the fraud exception’, The Cambridge Law Journal, Vol. 56, no. 2, pp. 284-290. Pickering, Murray A. 1968, ‘The Company as a separate legal entity’, The Modern Law Review, Vol 31, no. 5, pp. 481-511. Read More