Rationale and Impact of the of Salomon v. Salomon - Case Study Example

SALOMON V. SALOMON By       s and the Salomon v. Salomon IntroductionSalomon carried out his corporation as a sole trader. He later sold the business to an incorporated company for being titled A Salomon and Co Ltd. The members of the company were Salomon, his wife and his five children who had each $ 1 share each. The incorporated Corporation bought the business for $39,000 where Mr. Salomon contributed for 20,000 further shares. Conversely, the company did not pay for $10,000 shares where instead they issued Salomon with series of debentures giving him a fluctuating charge on its assets. When the corporation failed to succeed in its dealings the company’s liquidator vied that the fluctuating charge must not be esteemed meaning that Salomon would be held accountable for the company’s debts. In its ruling, the court held that despite Mr. Salomon having control over the company, it was neither his agent nor trustee, because the company operates its business on its own and has its own rights that are separate from the person controlling the company. Therefore, the charge that was given to Mr. Salomon was valid meaning that he was entitled to be paid his debt even if other creditors of the company would not be compensated. This is because the company did not have sufficient funds and assets to reimburse all the creditors (S v Salomon & Co Ltd U.K (1897) AC 22). In the Solomon v Solomon case, Lord Halsbury LC stated: … It seems to me impossible to dispute that once the company is legally incorporated it must be treated like any other independent person with its rights and liabilities appropriate to itself. In addition, that the motives of those who took part in the promotion of the company are irrelevant in discussing what those rights and liabilities are. (S v Salomon & Co Ltd U.K (1897) AC 22) Therefore, a company is a separate legal entity that is distinct from its members or directors even when it has been established that those individuals hold shares in the company. Rationale of the case of Salomon v. Salomon There were various principles that were created out of the case of Salomon v Salomon. For example, besides being established that a company is a distinct legal entity, the courts also established that a business has the right to contract with its controlling member. This meant that; having a separate legal personality from its directors the organizations liability was its own and for that reason, they had the right to make decisions on behalf of the company. This issue was emphasized in the case of Lee v. Lee’s Air Farming Ltd (1960) A.C. 12 (New Zealand P.C). The appellant’s husband formed the respondents company for the aim of carrying out the business of aerial top dressing. The nominal capital of the company was $ 3000 shares of $ 1 each. Mr. Lee owned 2999 shares, while the final share belonged to the solicitor; Mr. Lee was the vast majority shareholder and was the sole governing director. When Mr. Lee died while at work, the wife who was the appellant requested for compensation under the New Zealand Workmen’s Compensation Act of 1922, it was held that since Mr. Lee was the governing director of the company, he could not be held as a servant of the company. On appeal, it was held that, the company and Mr. Lee were two different legal entities and for that reason, they were capable of entering into legal relations with one another. Meaning that they had entered into a legal relationship for him to be the director of the company; therefore, it was a servant master relationship making him to fit the definition of a worker (L v Lee’s Air Farming Ltd (1960) A.C. 12 (New Zealand P.C). Therefore, as the shareholder he could not control the course of events in the corporation because it would affect the validity of his contractual relation and obligation with the company. For that reason, it was held that the company and the deceased were separate legal entities hence there was a contractual relation that rose between them enabling the company to give an order tops the deceased. The court held that the case was a consequence of Salomon’s case that a person could function in dual capacities; thus, allowing the Lee’s widow to be entitled to compensation. Salomon’s case further established that the company has the right to own and dispose property because it is a distinct legal entity from the shareholders and directors. In the sense that, the company can buy property and dispose it at any time they want as the property is owned by the corporations and not the individuals that run the company or business. It has been established that the property of the company belongs to the company and not its members; therefore, neither a creditor nor shareholder has insurable interest in the properties of the company. This was established in the case of Macaura v. Northern Assurance Co. Ltd (1925) AC 619. In this case, Macaura agreed to sell all the timber both felled and standing to Irish Canadian Saw Mills Ltd on the estate in return for all the issued share capital of the corporation that was to be held by himself and his nominees. He further granted the company a license to enter the estate and pull down the remaining trees, and use the sawmill. The timber and tree were stored in the estate and a fire broke out destroying the timber in the estate. Macaura sought a claim with the insurance company where the insurance company indicated that he had no insurable interest in the timber. This is because the timber belonged to the company and not to Macaura (M v Northern Assurance Co. Ltd (1925) AC 619). The House of Lords agreed with the insurance company holding that the timber belonged to the company and not to Macaura even though he was the owner of all the shares in the company. Lord Wrenbury stated, “A member even if he holds all the shares is not the corporation and neither he nor any creditor of the company has any property legal or equitable in the assets of the corporation” (M v Northern Assurance Co. Ltd (1925) AC 619). With that said it is clear that the company is a separate entity from individuals that are creditors or shareholders of the company. For that reason, any liability that falls on the organization does not fall on the individuals as the corporation has the right to be sued and to own property. The case of Salomon brought about the doctrine of separate legal personality, which elucidates that an incorporated company gains a separate legal personality that is distinct from that of its members. By gaining a separate legal personality, the company becomes capable of bearing its own rights and obligations. The courts have been keen to uphold the doctrine of separate legal personality, but it has become necessary to deviate from this doctrine through the doctrine of “lifting the corporate veil” The doctrine of separate legal personality has two elements that include that a company’s property belongs to the company and not to its directors. Secondly, a company is liable for its own debts and liabilities meaning that directors and shareholders are not responsible for paying creditors when the company becomes insolvent as was established in the case of Salomon v Salomon & Co Ltd. The courts have legalized the use of corporate form of small partnerships and sole traders. The courts concluded that when business partnerships are placed in the manner required by law, the company becomes a new legal entity separate from its shareholders. This is because when the company only complies with the law and all issued share are held by the individual then the company still becomes a separate legal entity. Additionally, the court held that it is possible for business people not just to limit their liability for the capital invested in their business entity, but also to determine the dangers for signing bonds rather than shares. The courts have allowed some exceptions to doctrine although they have been keen to remove exceptions that the courts no longer need, as they are obsolete in the interest of justice. First, if a company is created as a façade or sham the courts have pierced the veil of incorporation. Where a company is formed merely to cover up or disguise the real purpose of the corporate director this was held in the case of Gilford Motor co Ltd V Horne (1933). The defendant was an ex-employee of the Gilford motor company, his employment contract if he could not solicit the customers of the corporation after his contract of employment was terminated. However, in order to defeat the negative clause that had been inserted in the contract he incorporated a limited company in his wife’s name; making him to manage to solicit customers. Gilford Company brought an action against him where Horne argued that it was the firm that was attracting the clients and not him as the company was a separate legal entity. The court if Appeal held that the company was created as a device that was supposed to mask the effective carrying on of business of the defendant. Therefore, the main aim of incorporating the company was to perpetrate fraud. In this case, it was found that the company was used as a façade to hide the facts of a matter, which made the veil of incorporation to be lifted. Consequently, this argument was upheld in the case of Linsen International Ltd v Humpuss [2011] EWHC 2339 (Comm) & [2011] where the court of Appeal explained that the Veil of incorporation would be pierced when it was being used as a façade. Therefore, through the set precedents it is clear that the courts have taken a strong line against fraud. This is expected because the law should be utilized for the advantage of the unjust and rogue. This exception is in the interest of justice meaning that it does not undermine the doctrine, but is a logical exception. The course of action is necessary in order to give legal effect to the certainties of the business. Secondly, when a parent company and subsidiaries are involved in some cases the veil is pierced. In that, when it appears that a subsidiary company is carrying out a business as the agent of the parent company to avoid prevailing legal obligations then the veil is pierced. This was established in the case of DHN v Tower Hamlets London Borough Council [1976] 1 WLR 852 the court held that a company premises where facing a compulsory purchase order that was possessed by another company could be reimbursed as a whole. The court held that the subsidiaries and parent companies were held to be one economic unit. In the case of Adams v. Cape Industries plc [1990] Ch 433 (CA) it was clarified that the separate legal personality of a company can only be unheeded only if a subsidiary is an agent of the parent company. The court explained that there is no general principle that all corporations in a commercial group of companies are viewed as one. Therefore, this exception to the separate legal personality does not undermine the doctrine but assists the court in finding the underlying cause of definite issues. In case it is established that a company is formed in order to avoid future liability such as indulging in risky business venture that may end up failing. The courts may not allow such companies to be formed in order to avoid performing an existing legal duty. This was held in the case of Jones v. Lipman (1962) one WLR 832 where the defendant entered into a contract with the plaintiff for the sale of land. However, before the conveyance, the defendant changed his mind and he did not want to complete the sale. Therefore, he formed a company in order to avoid the traction and sold the land to the company where he and his solicitor were the shareholders. He informed the plaintiff that he could not conclude the transaction because he no longer owned the land as the company was now the lawful owner. The Judge in his ruling referred to the case of Gilford v. Horne where he established that the company was created as a mask, which Lipman held before his face in the attempt of avoiding recognition, by the eye of equity. For that reason, the court awarded specific performance against Lipman and the Company. Impact of the case of Salomon v. Salomon The doctrine in the Salomon’s case has been held to be a two-edged sword where it has been established that at a general level it was a good decision. This is because it established that corporations are separate entities. The case gave the company’s all the requisite attributes with that made them become the powerhouse if capitalism (Wallace, 2002, P. 78). However, the decision made by the House of Lords in the case was a bad decision in the sense that, by prolonging the benefits of incorporation to small private enterprises, the case has promoted fraud, as well as the evasion of legal obligations. The decision made in the Salomon’s case is internationally recognized as the authority for the doctrine of separate legal entity in corporations. The case affirms that upon incorporation a new and separate artificial entity is created, which makes it distinct from a person at law. Because it has its own personality separate and independent of those of the individuals that formed it, who direct, invest m one in it and manage its operations (Rickett, 1998, P. 67). Additionally, the rights and duties of the corporation are not the rights and duties of its members or its directors who are obscured by the corporate veil of incorporation that surrounds the company. In modern corporate law, the recognition of separate legal entity has been established in the case of MacLaine Watson & Co Ltd v. Department of Trade and Industry ( 1988) 3 WLR 1033. Internationally, every legal system that has attained maturity tend to be compelled by the increasing complexity of human affairs to create companies that are not men. Therefore, there has been an unbroken bond between the judicial and legislative circles in relation to the separateness of the legal personality. According to concession theorist, the corporate personality is a privileged that is granted by the state to enable legal and business convenience as the people managing the corporation have a clear understanding of their roles in the organization. By so doing, neither the directors or members interfere with the running of the corporation, as well as, their duties and obligations. However, the natural entity theorists arte of the opinion that the separate legal entity is significant in giving the legal effect to the natural fact that business entities as a consequence of human interaction and initiative has its own capacity and will for action. Salomon’s case has impacted a lot on the issue of company law in the sense that, as a registered company, which is the case for most companies today they are capable of being suing and being sued as established in the case of Foss v. Harbottle (1843) 67 ER 189. Secondly, a company has perpetual succession as was established in the case of Regal Hastings Ltd v. Gulliver (1942) one All ER 378. Thirdly, a corporation has the right to enter into a contract using its own name and the company has the power to acquire, hold, and dispose of property as was held in the case of Macaura v. Northern Assurance Co. Ltd (1925) AC 619. The attributes brought about by the Salomon’s case indicate clearly that the doctrine of separate legal entity is well established and recognized as business organization run their business with defines duties and obligations. Although the case brought about good doctrines, it is clear that there were negative attributes that resulted from the doctrine. First, small enterprises and business have found loopholes in the doctrine where they have used as a form of running away from liability and evasion of government rules, as well as, fraudulent acts. However, it has been established that the negative issues that are brought about by the Salomon’s case cannot outweigh the positive attributes of the doctrine of separate legal identity. For that reason, the established of the doctrine has played a major role in shaping the corporations as their duties and obligations are monitored. Conclusion In conclusion, the established of the doctrine of separate legal identity in the Salomon’s case has played a major role in shaping and developing modern capitalism, as well as, the economic and social wealth that is generated from the establishment of corporation. For that reason, it is significant for all persons who direct, invest or control the separate legal entities to ensure that they are acting according to the law. Applying the Salomon’s case in the daily running of the company’s is important, as it will act as a preventive measure for organization that wants to evade the law. References Adams v. Cape Industries plc [1990] Ch 433 (CA) DHN Food Distributors Ltd v Tower Hamlets London Borough Council [1976] 1 WLR 852 Foss v. Harbottle (1843) 67 ER 189 Jones v. Lipman (1962) one WLR 832 Lee v. Lee’s Air Farming Ltd (1960) A.C. 12 (New Zealand P.C) Linsen International Ltd v Humpuss [2011] EWHC 2339 (Comm) & [2011] Macaura v. Northern Assurance Co. Ltd (1925) AC 619 MacLaine Watson & Co Ltd v. Department of Trade and Industry ( 1988) 3 WLR 1033 Regal Hastings Ltd v. Gulliver (1942) one All ER 378 Rickett, C. E. F. (1998). Corporate personality in the 20th century. Oxford, Hart. Salomon v Salomon & Co Ltd U.K (1897) AC 22 Wallace, C. D. (2002). The multinational enterprise and legal control: host State sovereignty in an era of economic globalization. The Hague, M. Nijhoff. Read More