Business Law - Salomon v Salomon & Co Ltd - Case Study Example

Business Law Introduction Salomon v Salomon & Co Ltd constitutes a landmark case, in which the court established the principle of corporate veil. The court held that the company had a separate personality that was distinct from that of its members. Under certain circumstances, the courts exhibit considerable willingness to pierce the veil of incorporation. This effectively sets aside the legal personality of the company, and is done in the interests of justice (Knowles, 2010). However, it is difficult to predict, in which situations the courts would lift the corporate veil. In the Salomon case, Lord Halsbury had stated that a company would acquire an independent persona upon legal incorporation. Such entities were to be treated like any other independent person, with relevant rights and liabilities. The rights and liabilities of the company are independent of the objectives and motives of its promoters (Shum, 1991, p. 53). In this case, the court formulated the principle of limited liability by stating that a company was a legal entity that was distinct from its members. This constitutes the veil of incorporation, and the company enjoys a corporate personality that is distinct from its members (Lifting or Piercing the Corporate Veil). The detection of fraud or misconduct in a company, results in the piercing of the corporate veil. This enables the implementation of corrective measures in such companies. Some limitations have been imposed on the lifting of the corporate veil. For instance, the corporate veil can be pierced if the internal affairs of the company depict fraudulent activity. Furthermore, the status of a shareholder should be that of a natural person. (Sahni, 2005, p. 6). This situation is not always true, because there are several instances, wherein a company is a shareholder of some other company. Limited Liability Under normal circumstances, a limited company’s members are not directly liable to creditors, in respect of the debts of the company. This notion of limited liability was established in Salomon v Salomon & Co Ltd. It states that a company is a legal entity that is distinct from the members of that company. Under this principle, the liability of a limited company is restricted to the amount unpaid on the shares of the company (Shum, 1991, p. 55). There are cases in which fraudulent directors or members of a company have abused the veil of the corporate personality, in order to further their vested interests and to indulge in fraudulent activities. In some cases, the corporate veil has been blatantly utilised to conceal the misconduct of the company’s directors. In such cases, the courts have been more than willing to lift or pierce this corporate veil and expose the miscreants responsible for the fraud (Lifting or Piercing the Corporate Veil). As such, the courts, whenever the situation so demands pierce the corporate veil and determine the true beneficiaries concealed behind it. Albeit, the law deems the members, promoters, and shareholders to be the true beneficiaries of the company. The reality is otherwise and the true owners are an association of individuals who enjoy the benefits derived from it. The Salomon’s principle casts a veil over the corporate personality of the company, which attempts at concealment from the courts (Lifting or Piercing the Corporate Veil). Nevertheless, the courts have been seen to frequently pierce the corporate veil and identify the entities responsible for fraudulent activities. In the UK, the courts widely employ the principle established in the Salomon case. This attitude can be attributed to its treatment of corporate groups (Prentice, 1996, p. 483). Moreover, English law permits the transfer of risk, by using a corporate personality. The courts subscribe to this policy, as was clearly discernible in re Baglan Hall Colliery Ltd, wherein the owners of the company sought to convert their business into a limited liability company (Prentice, 1996, p. 484). Their intention behind this initiative was to avoid liability. It was held by the Court of Appeal that these owners could transform their colliery into a limited liability company, under the provisions of the Companies Act, so as to circumvent the incurring of liability. This policy of transferring risk has never encountered any serious challenge, in the UK (Prentice, 1996, p. 484). Interests of creditors Voluntary creditors, dealing with a limited liability company can safeguard their business interests, by increasing prices or by insisting upon the provision of security. These measures are not available for the involuntary creditors. Although, limited liability and the policy of risk shifting are capable of causing considerable harm to involuntary creditors, these have not been contested. There are several reasons for this state of affairs. Some of these are; in the UK, compulsory insurance has to be obtained against industrial and traffic accidents, which serves to protect the interests of many involuntary creditors (Prentice, 1996, p. 485). In addition, small trade creditors or involuntary creditors do not possess the wherewithal and cohesion to form an effective group. Moreover, the claims of such creditors are sufficiently small to be considered as petty expense. Furthermore, the English courts are strong upholders of the legal principle of stare decisis or precedent. This provides them with a very limited jurisdiction to deviate from earlier rulings. However, on occasion, the House of Lords has been observed to depart from its previous rulings. Nevertheless, such instances are few and far in between, and the norm is to adhere to the doctrine of precedent (Prentice, 1996, p. 485). The claim of creditors is limited, due to the fact that the liability of a limited company is restricted to its assets. As such, no creditor can make a claim against the assets belonging to the members, directors or officers of the company. The decision taken by the House of Lords in Salomon, recognised that the creditors had been trading with Salomon and Co Ltd. This had enabled them to evaluate the probable risk involved in their transactions with this company (Dunn, 2005, p. 344). Rights of Shareholders Shareholders in the UK, obtain several rights under the aegis of the Companies Act 2006 that seek to protect them against unfair prejudice. As a consequence, the members of a company can approach the court, regarding the conduct of the company’s affairs, if the latter are perceived to be inimical to their interests (Maintenance of Finance and Capital). One of the most controversial features of corporate law is that of piercing the corporate veil. Such piercing of the corporate veil is in general, quite uncommon and conducted by a court of law. To the extent possible, courts favour the rule of corporate personality, which is based on the notion that a company constitutes a separate legal entity. This legal entity is independent of the shareholders, and consists of its own rights and duties. Furthermore, it can sue and be sued (Forji, 2007). The mere existence of fraudulent activity in a company, does not justify the piercing of the corporal veil. For instance, in Dadourian Group v Simms, one of the co – owners had falsely represented that he was merely an intermediary. This rendered him liable for having performed a deceitful act (Dadourian Group International v Simms and Ors, 2009). Nevertheless, the court did not pierce the corporate veil, and this ensured that there was no liability relating to the companies breach of contract. In the absence of deception, the courts have exhibited a marked reluctance to lift the corporate veil. (Ohrenstein). The corporate veil will not be pierced, merely on the grounds that such action would be in the best interests of justice. Case Law In Jones v Lipman, the defendant, Lipman, had entered into a contract with the plaintiff to sell his house. Subsequently, he transferred the house to his company. The plaintiff initiated legal action against the defendant, and the court held that the defendant had used the company, as a façade, and had transferred the house to the company, in order to avoid the legal obligation of selling it to the plaintiff (Jones v Lipman, 1962). The court ordered specific performance of the contract. In Giford Motor Co Ltd v Horne, Horne, an employee of Giford Motors, was under an obligation not to solicit the customers of the company when he left employment. However, Horne violated his obligation, after leaving the company. He formed his own company and solicited the customers of Giford, and attempted to employ the corporate veil to mask his breach of restrictive covenant (Giford Motor Co. Ltd v Horne, 1933). The court stated that he had utilised the corporate veil as a cloak or pretence. Moreover, in Trustor AB v Smallbone, a director of the company transferred money from the company account to his account and to another company’s account. That company was controlled by him, and subsequently, he employed this money for his own purposes (Trustor AB v Smallbone, 2001). The court lifted the corporate veil in the interest of justice. In Kensington International Ltd, the court pierced the corporate veil, which demonstrated that the mere presence of fraudulent activity was not the sole criterion for arriving at a decision to lift the veil of incorporation. In Gencor v Dalby, the court pierced the corporate veil, because the defendant had constituted the company to circumvent liability. The court ruled that this company was the alter ego of the defendant (Gencor v Dalby, 2000). The courts extend this practice of piercing the corporate veil to even agency cases. This was evident in Re: F.G. Films Ltd (Re: F. G. Films Ltd). Moreover, the courts have pierced the corporate veil of a group of companies, in order to identify a company in that group (DHN Food Distributors Ltd v Tower Hamlets LBC, 1976). In Briggs v James Hardie & Co Pty Ltd, the court expressed the opinion that the principle of the Saloman case reveals a lack of commercial reality. It clearly stated that Salomon principle was unsuitable to present practical use (Briggs v James Hardie & Co Pty Ltd , 1989). Conclusion The courts lift the corporate veil in cases involving fraud and misconduct. Thus, lifting the corporate veil is a legal decision. The incorporation of a company limits the liability of the company to the extent of the property owned by the company. The corporate veil provided immunity to the directors, officers, and shareholders of a company, in respect of the debts of the company. In some cases, the directors or officers of the company may utilise the limited liability principle for advancing their interests. In such cases, the courts attempt to pierce the corporate veil and expose the entities who had committed the tort or misconduct. Across the various jurisdictions on the globe, the application of this intervention is determined by the manner in which the domestic legislation perceives it. The best examples of legal systems that frequently indulge in the piercing of the corporate veil are provided by the common law jurisdictions. It has been observed that the courts, under this legal system, decide on the basis of a case’s merit. All the same, in instances entailing agency, sham, unfairness and group enterprises, the courts tend to pierce the corporate veil. The piercing of the corporate veil could render a shareholder personally liable for an unlimited amount. This holds good, despite the statutory provision that limits shareholder liability. It can be surmised that, although courts are not proactive in lifting the corporate veil, if the situation so warrants; their intervention proved to be beneficial to all the stake holders of the company. References Briggs v James Hardie & Co Pty Ltd , 16 NSWLR 549 (1989). Dadourian Group International v Simms and Ors, EWCA Civ 169 (2009). Dunn, E. (2005). No soul to be damned and no body to be kicked,. Sydney Law Review, 27, pp. 339 - 344. Forji, A. G. (2007, September 28). The Veil Doctrine in Company Law. Retrieved February 11, 2011, from http://www.llrx.com/features/veildoctrine.htm Gencor v Dalby, 2 BCLC 734 (2000). Giford Motor Co. Ltd v Horne, Ch 935 (1933). Jones v Lipman, 1 WLR 832 (1962). Kensington International Ltd v Congo, EWHC 2684 (2005). Knowles, G. (2010, March 10). Piercing the proverbial corporate veil. Retrieved February 11, 2011, from http://tamrinswitch.wordpress.com/2010/03/10/piercing-the-proverbial-corporate-veil/ Lifting or Piercing the Corporate Veil. (n.d.). Retrieved February 6, 2011, from http://www.scribd.com/doc/18384362/Lifting-the-Corporate-Veil Maintenance of Finance and Capital. (n.d.). Retrieved February 11, 2011, from http://www.oup.com/uk/orc/bin/9780199544455/resources/answer_guidance/answerguidance_ch25.doc Ohrenstein, D. (n.d.). Lifting the Corporate Veil. Retrieved February 11, 2011, from http://www.radcliffechambers.com/articleDocs/374.pdf Prentice, D. D. (1996). Veil Piercing and Successor Liability in the United Kingdom. Florida Journal of International Law, 10, pp.469 – 485. Re: F. G. Films Ltd, (1953) 1 AER 615. Sahni, B. (2005). The Interpretation of the Corporate Personality of Transnational Corporations. Widener Law Journal, 15, pp. 1 – 45. Saloman va Saloman & co. ltd, AC 22 (1897). Shum, C. (1991). Business associations: an introduction to agency, partnership and company law. Hong Kong University Press. Trustor AB v Smallbone, 2 BCLC 436 Chancery Division (2001). Read More