The Rationale and Impact of the Decision on Company Law - Essay Example

The rule in Salomon v Salomon & Co [1897] AC 22 has been described as one of the corner stones of English Company Law. “ “Discuss the rationale and impact of the decision on company law. “ Introduction In the famous leading case Salomon v Salomon & Co, it was held that the company is distinct from its members. It has separate legal identity, and it is a legal person and can own assets in its own name and borrow money in its name for the business needs. A company can sue others or can be sued by others. The debts’ contracts by the company are its own, and a member cannot be held accountable for it. However, there are some occasions, where court disregard the separate corporate entity and may pierce the corporate veil to find out the truth. When a company form of business is used for cheating or fraud purposes, then, the courts will not keep silent. Thus, this research essay will analyse the Salomon’s case verdict in detail and will examine the Salomon’s case rationale and impact of the decision on company law (Hannigan 2013:11). Salomon v Salomon & Co [1897] AC 22- An Analysis Mr. Salomon carried over a shoe and leather manufacturing unit. He later sold that business to a company which was incorporated by him. The company’s authorised share capital comprised of 40,000 shares of £1 each. Not all the authorised share capital was called for subscription. In consideration of the sale of the shoe business to the company namely Salomon & Co, Salomon was allotted with 20000 fully-paid shares and also secured debentures worth of £ 10,000 and Mrs. Salomon, and their five children held one share each. Moreover, debentures were allotted to a third party, Broderip, in consideration for the amount of loan advanced to the company. Salomon & Co later witnessed financial difficulties and finally was in wounding up stage, with total debts of £ 77,000. The realisations of company assets were adequate enough to defray the loan by the company to Salomon and Broderip, but not adequate to pay unsecured creditors of the company. The unsecured creditors, acting through the liquidator initiated an action against Mr. Salomon demanding that he was accountable to indemnify the liquidator for the unsecured debts of the company from the personal assets of the company (Belcher 2014:3). Decision: The Company was not a shadow, trustee or agent of Salomon. Salomon & Co was a distinct, separate legal entity, diverse from its members, despite the fact that one single individual owned the majority of the shares of the company and having control of affairs of the company. It was held that Salomon was, hence, not accountable or liable for the company debts (Borough 2005:3). The lessons learnt from the Salomon v. Salomon & Co is that company is distinct from its members. The case also demonstrated the limited liability of members which is unique to the company form of business as differentiated from other forms of business-like partnerships or proprietorship where liability is unlimited in nature (Davies 2010:6). It is to be noted that the Companies Act, 1862 of UK specifically permitted companies to be formed with seven shareholders with the limited liability. Using this, Aron Salomon incorporated a company as per the provisions of the Companies Act 1862 on 28 July 1892. Salomon held 20001 shares in the company and his wife, daughter and his four sons were held each one share thereby making seven members of the company with a limited liability (Grantham & Rickett 1998:215). As per Lord Halsbury, in Salomon case, a company as a legal entity, distinct and separate from its members, the company must be construed like any other human being with liabilities, and rights appropriate to itself and this view is consented in Maclaine Watson & Co Ltd v International Tin Council [1989] 3 AII ER 523 at 531(Chitty & Beale 2012:894). It is the company which carries over the business, it is the corporation that enters into the contracts and borrows money for the business. Company’s properties are not necessarily considered to the properties of its members even the entire shareholding is held by a single shareholder either directly or indirectly as held in Macaura v. Northern Assurance Co [1925] AC 619 at 626-7, HL ( Pathak 2007:356). The company has perpetual succession and existence, and this continuity is significant. The death of a member does to make the company to strip its existence. The membership of a company may constantly be changing but the company is still in existence until steps are initiated to windup the company as per the provisions of the Companies Act. Thus, the debts are the debts of the company and not the shareholders of the company whose only duty in a company limited by shares is to contribute to the company’s assets such an amount , if any, unpaid on the shares owned by him as per s 3(2) of CA 2006. S 74(1) (d) of CA 2006 states that if the shares of the company are fully subscribed or fully paid-up , then , the shareholders have no further liability as a shareholder(Hannigan 2012:44). A company can employ people to manage its business and can employ its majority shareholder also as an employee of the company. This was acknowledged in Lee v. Lee Air Farming Ltd where Mr. Lee incorporated a company to carry over the business of aerial topdressing. The company’s share capital was comprised of 3000 £1 share and out of which, 2999 shares were allotted to Mr. Lee and the balance 1 share was held by Mr. Lee’s solicitor. Mr. Lee was also employed by the company as a pilot to carry out aerial topdressing. In an accident, Mr. Lee was killed and Mrs. Lee claimed from the company, compensation under worksman compensation. The company at the instruction of the insurer defended the claim made by Mrs. Lee. The judges in this case cited the Salomon’s case and agreed that Mr. Lee can act in various roles, as managing director and employee, distinctive from the company. That he was the major shareholder and managing director administering the company did not undermine the sanctity of the contract between the company and himself, as an employee. It was held that Mrs. Lee was entitled to claim compensation (Bourne 2013:19). Hence, in the case of a company, the members’ liability is limited to the extent of the value of the shares subscribed by the shareholder and thus, a shareholder is not obligated to pay in excess of the amount subscribed by him from his personal property. Though, Salomon devised the strategy to allot secured debentures to him, but he had to be given preference in settlement of debts from the available funds by the liquidator when the company went into liquidation before any settlement was made to unsecured creditors. This is because under the UK Company Law, secured creditors will have precedence in settlement than unsecured creditors. Though the unsecured creditors alleged that the company was sham, and all the shares were held by Salomon and his family, but as Salomon structured the same within the ambit of UKs company law, the court found in favour of Salomon (Cassidy 2006:42). Company is Diverse from its Members A company is distinct from its members, and it has separate existence from its members was judicially acknowledged by the House of Lords in Salomon case as early as in 1987. The case of Salomon demonstrated it beyond doubt that the company is diverse from its members. Courts, will not generally, penetrate or pierce this veil (Nyombi 2014:66). The general rule as regards to separate corporate personality does not seem to permit for many exclusions. The rule that a company registered under the Companies Act of UK is an artificial legal entity which is distinct and separate from its members of which it is related and as such, is having power to sue others and can be sued by others. This can be observed as fundamental of the UKs company law. Thus, the Salomon case revealed that companies are by their very nature fictional or artificial persons are often called as a “mere abstraction of law.” However, the company is owned and managed by individuals who employ the veil of incorporation so as to enjoy the much advantages connected with it. This is analogues to the flag convenience as employed by ship operators and owners (Dewhurst 2008:228). The court may disregard in the interest of justice where a company is incorporated mainly with some objectives like circumventing or defeating law or defrauding creditors. In “Jones v. Lipman, (1962) ALL E.R. 442”, to avoid specific performance of the contract, a land was transferred to a newly incorporated company by Lipman. Lipman, his clerk and solicitors were the only members of the company. The court looked at the reality of the case, disregarded the transfer and held that the company should convey back the land to the claimant Jones (French, Mayson & Ryan 2013:136). Where the company is in control by the enemies, then, court will disregard the separate entity concept and will look into who were the persons in real control of the company and will declare the company to be an enemy company as held in “Daimler Co Ltd. V. Continental Tyre & Rubber Co Ltd.,” (1916) 2 A.C.307 during the First World War (Tyagi & Kumar 2003: 34). The court will not hesitant to pierce the corporate veil when the company was cloak or sham. In “Gilford Motor Co, Ltd v. Horne “(1933) Ch.935 C.A. In this case, defendant Horne was the erstwhile employee of the plaintiff company. He resigned the from plaintiff company and started his own company to deal the plaintiff’s customers which were against the covenant with his previous employer. The court granted an injunction against Horne and his company to forbid them from dealing with the same kind of business and to solicit the customers of Plaintiff Company. The court observed in this case that the company floated by Horne was a “mere sham or cloak for the purpose of facilitating the defendant to infringe the covenant against solicitation of plaintiff’s customers or “a devise, a stratagem” (Goldsworthy 2011:149). Courts have extended the separate personality to the group company background where subsidiary companies are owned and managed by parent companies. In Adams v Cape industries Plc, for the objectives of deciding whether under the English law , the New York courts had jurisdiction over Cape Plc, the U.K. based parent company, which had no physical presence in U.S.A except where its subsidiaries are in operation in U.S.A. In the above, the main issue was whether U.S. court verdict against Cape Industries Plc could be implemented in UK? The parent company in UK did not sell asbestos in U.S.A. How can they be accountable when parent and subsidiaries are separate legal entity? However, it is argued that whether Parent Company can be pursued under the tort law which imposes a duty of care on relation to its subsidiary (Kershaw 2012:147). In Newton-Sealey v Armour Group Services Ltd [2008] EWHC 233 , an employee of the subsidiary company (AG (Jersy) initiated a claim against the parent (AG plc) for damages for the injury suffered by him during his course of employment at Iraq as a security guard. The claimant sued the UK parent in contract and tort. However, the contractual claims were turned down by the UK court on the footing of separate legal entity between parent and subsidiary ( Soyer & Tettenborn 2014:290). Chandler v Cape Plc [2011] EWHC 951 (QB) - In this case, the claimant was an employee of Cape Building Products Ltd (Cape Products) which was wholly owned subsidiary of Cape Plc. ( Pertrin 2013:603). The claimant alleged that during his course of employment, due to exposure to asbestos, he contracted asbestosis. Nonetheless, at the time of action being brought, the company Cape Building Products Ltd was not in existence. Moreover, during his course of employment with Cape Products, no insurance policy was there in force, which would have covered the asbestosis claims. Hence, the claimant initiated an action against parent company arguing that the parent company was responsible for his suffering due to duty of care as regards to damages witnessed by Cape’s products by the employees due to their vulnerability with the asbestos products. Cape Plc while turning down the claim of the employee but acknowledged that if the court found that it owed a duty of care to the claimant that it had functioned negligently and was in infringement of that duty. The court found that Cape Plc had a duty to forbid Cape products from causing injury to the claimant (Kershaw2012: 147). In DHN Ltd v Tower Hamlets [1976] 1 WLR 852, Lord Denning explained that a group of companies was in realism a single economic body and should be treated as one (Bourne 2013:26). However, in “Woolfson v Strathclde R.C.” [1978] SLT 657, the House of Lords turned down the findings in DHN Ltd case and held that the corporate veil of incorporation would be maintained unless it was a façade (Russell & Cohn 2012:10). A ruling of tortious liability against a shareholder cum director for activities done through the group companies has the chance of contradicting the Salomon principle. In Williams v Natural Life Health Foods Ltd [1998] 2 AILL ER 577, the House of Lords highlighted the Salomon principle in the background of a negligent misstatement claim. The claimant who was a franchisee for NLHF sued against NLHF for loss witnessed by him due to the negligent information contained in the brochure issued for inviting franchise. NLHF ceased to trade later and was shut down. The claimant then prolonged the action against the managing director cum majority shareholder. The House of Lords appeared specifically aware that the impact of this claim was to try to invalidate the protection extended to the limited liability concept. In this case, the House of Lords was of the opinion that an employee or a director of a company could only be made personally accountable for neglectful misstatement if there was justifiable reliance by the claimant on the presupposition of personal accountability by the director so as to establish a unique relationship between them. However, in this case, there was no adequate corroboration available in the present case that there had been any personal dealings by the director which could have been communicated to the claimant that the managing director was ready to bear personal liability for the franchise agreement. The same line of verdict was also given in “Noel v. Poland “[2002] Lloyd’s Rep.IR 30) (Kelly et al 2014:240). Conclusion Salomon v. Salomon & Co case demonstrated the concept beyond doubt that the company is diverse from its members. Thus, the Salomon case revealed that companies are by their very nature fictional or artificial persons are often called as a “mere abstraction of law.” Generally, courts will not penetrate or pierce the corporate veil. However, the court may disregard the separate entity concept in the interest of justice where a company is incorporated mainly with some ulterior objectives like circumventing or defeating law or defrauding creditors as held in Jones v. Lipman. The court will not be hesitant to pierce the corporate veil when the company is a cloak or sham as held in Gilford Motor Co, Ltd v. Horne. In Woolfson v Strathclde R.C, the court held that the corporate veil of incorporation would be maintained unless it was a façade. In Williams’s v Natural Life Health Foods Ltd and in Noel v. 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