The Salomon Principle in the Modern Context - Assignment Example

A CRITICAL ANALSIS OF THE LEGAL PRINCIPLES OF THE CASE OF SALOMON V SALOMON [1897] AND ITS APPLICATION IN THE CONTEXT OF CORPORATION LAW Contents Introduction 3 Salomon V Salomon 3 Legal Issue 4 Judgement 5 Abuse of the Corporate Form 7 The Veil of Incorporation 8 The Salomon Principle in the Modern Context 9 Conclusion 10 Books 12 Cases 12 Introduction Most legal professionals argue that every branch of law is based on a particular case that formed the fundamental essence of that branch of law. Therefore, there are landmark cases that spell out various branches of law. Thus for instance, in contract law, the case of Balfour V Balfour creates the premise within which contracts are segregated from other aspects of law. Donohue V Stevenson also defines the very foundation on which the law of tort is built. In corporate law, the case of Salomon V Salomon1 defines the very essence of a company and its legal features. This paper will examine the fundamental elements of Salomon V Salomon and this is done within the framework of the legal features of this case and how it has defined and shaped company law in English Law today. Salomon V Salomon According to the facts of the case, Aron Salomon was a shoe manufacturer who had a Whitechapel High Street establishment. Salomon sought to convert his firm into a limited liability company. Therefore, in 1892, he formed a company [A Salomon & Co Ltd] and the company purchased the shoe manufacturing business for 40,000 £1 shares. This amount was quite substantial in 1892 when the transaction occurred for a company of that nature2. “His wife and five children subscribed to one share each. Salomon sold his business to the company. The company paid £30,000 to Salomon for the business. Salomon took £20,000 worth of shares in the company. He loaned the remaining £10,000 to the company through a debenture”3. Another set of debentures were issued to an unrelated third party, named Broderip whose debenture was turned in as evidence in the legal proceedings4. This means that the firm created a somewhat artificial system through which shares were created and nothing exceptional was done to merit the transfers. However, there was a legal transaction which implied that Salomon’s sole proprietorship was transferred to a corporate entity that had been formed by Salomon. In effect, Salomon owned 20,000 shares of the company whilst his seven relatives owned one share each, making the number of shares only 20,007. Legal Issue In 1893, soon after the incorporation, the main customer of Salomon’s business, the British government abrogated a contract with the company and the company went into liquidation after about a year of incorporation5. In the process, the company incurred a debt of £77,000 and after it was sold, there was an outstanding £6,055 which Broderip claimed £5,000 as a debenture or secured debt holder and Salomon also claimed the rest, £1,055 as the other debenture holder6. There was still a debt of £7,773 owing to other non-secured external creditors. The creditors and the liquidator sued for any money paid to Salomon to be returned to the unsecured creditors because by selling the business, Salomon overvalued the business and in the process, the business has failed and as such, it was a fraud on unsecured creditors if Salomon was allowed to go with the money paid for his debentures7. Judgement In the high court, the Judge Vaughan Williams ruled that Salomon created the company with the sole purpose of transferring his business to it8. This implies that the company and Salomon were on unit. And therefore, Salomon was to be seen as the agent of the company and he was the principal. As such, he was liable to the creditors for unsecured debts and had to pay from his own coffers. On appeal, Salomon argued on the premise that he was an independent and bona fide shareholder of the firm and as such, he was a completely separate and different entity from the A Salomon and Co Ltd. However, the Court of Appeal subjected this claim to the test of whether Salomon meant to follow the principle of independent incorporation in good faith or not under the Companies Act of 1862. In the process, the Court of Appeal found that the privileges of incorporation were intended by Parliament to apply only to independent bona fide shareholders who had a mind of their own who could make their own decisions and were not “mere puppets”9. Therefore, it was held that A Salomon and Co was a mere trustee who held the assets for Mr. Salomon and as such, Mr. Salomon was bound to indemnify the company’s debts. The Court of Appeal therefore held that A Salomon & Co Ltd was a scheme set up by Mr Salomon to defraud creditors. The House of Lords however overturned the decision of the Court of Appeal unanimously. They rejected all the arguments that asserted that the principles of agency and the common law principles of fraud were applicable to the case. They held that the Companies Act did not mention anything about the independence of the majority shareholders. Also, there is nothing in the Companies Act that mentions the proportion of interest or the independence of the majority. Hence, once the seven shareholders satisfied the minimum requirements for the formation of a company, then the principles of the Companies Act provided adequate protection for the majority shareholder without any recourse to the magnitude of shares held by the Salomon even though he was the overwhelming majority10. Therefore in essence the fundamental principle of Salomon V Salomon is that there is a legal separation rule that applied in English law that separated shareholders from a company they formed11. This forms the default position of English corporation law which asserts that a company has a separate legal form from its shareholders. Thus, companies have limited liability and this makes it different from other legal forms of businesses that might have other arrangements that limit the liability between the owners and the entity. The case of Salomon V Salomon was further tested in other cases. In the case of Lee V Lee Air Farming Ltd12 an individual formed a company with 3,000 shares and held 2,999 shares and handed only 1 share to his solicitor. The individual was the director, employer and worker and the article of association stated that he will hold these positions for life. In line of duty, the individual died and his widowed sued for compensation on the grounds that he was in active duty and was hence a worker. The matter was sent on several appeals. Finally, the New Zealand Privy Council held that it is possible for the individual to act as director and worker at the same time and employ himself in a legally binding contract as far as company law was concerned. This shows that company law creates separate legal personalities where the need arises. Abuse of the Corporate Form The principle of Salomon V Salomon indicates that in cases where an identifiable entity owns 100% shares in a corporate entity, there is no abuse of the corporate form. Therefore, in most situations it is common for a 100% wholly owned subsidiary’s management to submit questions relating to decisions to management of the parent company in order to determine how to run the company13. However, this does not normally indicate the abuse of the corporate form. However, in some cases, the courts might establish that there was a malicious intention for a company to be formed in order to abuse the corporate form. In Jones V Lipman14 it was held that in order to invoke the argument of the abuse of the corporate form, there is the need to establish that the controlling company was nothing more than a “device and sham, a mask which he [the incorporator] holds before his face in an attempt to avoid recognition by the eye of equity”15. Therefore, it is recognized from this that sometimes, when a firm is formed as a direct means to avoid some clear legal obligations and expectations, then the argument of the abuse of the corporate form can be invoked. This implies that the persons who formed the company can be held liable for using the purposefully-created company as persons who formed the company can be held liable for using the purposefully-created company to gain certain advantages. The Veil of Incorporation One of the maxims of Equity states that the doctrines of equity can be used as a shield, not a sword. English Law traditionally posits itself to prevent malicious persons from using various legal principles to conduct mischievous acts. Therefore, a clear limit has been placed on the principles and rules of the principle of Salomon V Salomon. In some cases, usually, in the case of fraud, the court might lift the veil of incorporation in order to attain certain ends consistent with the fundamental principles of justice. This is typically done on the basis of preventing fraud perpetrated with an intention to avoid certain obligations under law. In the case of Gilford Motor Co Ltd v Horne16, Horne had an employment contract with Gilford which prevented him from seeking jobs from clients of Gilford. However, Horne left Gilford and commenced business in the same industry. This was clearly in contravention of the agreement he had with Gilford. He sought legal advice and realized he will be in a legal breach if he continues to run the business in the industry. He therefore formed a company, JM Horne & Co Ltd and made himself, his wife and a friend the sole shareholders and directors. He advertised the company’s operations with various words that directly attracted customers of Gilford. Gilford took the matter to court and Horne argued that the company, JM Horne Ltd did not have any such agreement with Gilford. The High Court held that Horne set up the company because of his fears that he might breach the convention. Hence, the Horne was allowed to carry on trade with the company which was not in breach of the rules. However, Guilford appealed and the Court of Appeal reversed the decision. They granted an injunction because they found that there was evidence that JM Horne Ltd was formed to circumvent the limitation that is placed on Mr. Horne. This therefore indicates that in cases where a company is formed with the intention of avoiding an existing legal duty, the principles of Salomon V Salomon cannot be applied to such an entity. This is because the entity will fundamentally be flawed and its existence will be to enforce an illegality of avoiding a legitimate obligation. Hence, such a situation is wrong and must be discouraged by law. The Salomon Principle in the Modern Context Analysts have identified that the principle of Salomon V Salomon is an unyielding rock on which commercial law is based in the jurisdiction of English Law. From the cases relating to the removal of the veil of incorporation, many analysts were tempted to believe that the Salomon Principle had become extinct by the 1970s. However, some cases affirmed the fact that the principle is still applicable to modern legal contexts. In the International Tin Council Case17, this presumption that the Salomon principle was no more valid was rebutted with an obiter which stated that “the decision of this House in Salomon is as much law today as it was in 1896”18. This implies that the principle is a central one that continues to resonate in the world of English law and it will continue to be the case into the foreseeable future. In Adams V Cape Industries plc19, the Court of Appeal was invited to lift the veil of incorporation on a 100% owned subsidiary in order to take legal action against the parent company. This was seen as an important aspect of the case because it provided a practical solution to the legal problems that came with the case. However, the Court of Appeal insisted that the court is not free to depart from the principles of the case of Salomon V Salomon. This is because the Salomon principle is a fundamental basis for commercial law and it has to be respected by lower courts in the country. Hence, it is a case law that cuts across the courts of English law and must be viewed as a top-level case that provides a ratio that courts sitting on similar cases ought to be sensitive to. Conclusion This paper has critiqued the facts and judgement of the case of Salomon V Salomon. The paper has identified that the case relates to the foundations of company law. The case established that irrespective of the quantum of share ownership, a company has a completely separate legal identity from its owners. The company, once it comes into existence is totally different from its previous form and shareholders are to be given limited liability. However, there are some exception to this general principle and general rule. First of all, there is the case whereby a firm is set up to maliciously abuse the corporate form. In this case, the firm is set up as a device to mislead and create certain ends that are not consistent with the fundamental principles of justice in English law. On the other hand, the veil of incorporation could be pierced if a company is formed to avoid an existing legal obligation. In this case, the courts will prevent it from meeting this end by granting an injunction. The principle of Salomon is very relevant today. And courts have shown on several occasions that it is a principle they have to recognise. Even in a period where other cases have negated the fundamental premise, the principles are held to be central to corporate law in the English legal system. Books Cassidy, Julie. Concise Corporations Law. Sydney: Federations Press, 2012 McLaughlin, Susan. Unlocking Company Law. London: Routledge, 2014 Pathak, Singh. Legal Aspects of Business. New Delhi: Tata McGrawHill, 2013 Shum Clement. Business Associations; Hong Kong: HKU Press, 1991 Wallace Cynthia Day, The Multinational Enterprise and Legal Control Amsterdam: Martinus Nijhoff, 2012 Cases Adams V Cape Industries plc [1990] 2 WLR 657 CA Gilford Motor Co Ltd v Horne [1933] Ch 935 Jones V Lipman [1962] 1 WLR 832 Lee V Lee Air Farming Ltd [1961] AC 12 (New Zealand PC) Re: International Tin Council Case [1989] Ch 309, CA Salomon v Salomon & Co [1897] AC 22 Read More