Salomon vs Salomon & Co Ltd - Essay Example

Corporate Law Question 1 Key Issues The provided case study involving Simon, a majority shareholder and managing director of Slowgo Pty Ltd raises a number of legal issues. Before examining the legal issues emanating from this case, it is perhaps crucial to examine the key facts evident in this scenario. Firstly, Simon is the director of the Slowgo Pty Ltd and the majority shareholder. This means that he is the main controller and decision maker in the company. Secondly, it is worth noting that under his leadership as the managing director, the company incurred debts that supersede the company’s assets. The company owes creditors over $ 500, 000 which its assets cannot cover these debts. Moreover, it is worth noting that, Slowgo Pty Ltd is registered as a limited liability company. A critical look at the facts in this case study, several legal issues and questions emerge. It is worth questioning whether Simon and Slowgo Pty Ltd exist as separate legal entities. Issue pertaining to the privileges of limited liability and incorporation also arise. Furthermore based on the facts in this case study, the issue arises regarding whether or not share holders or directors are liable for company debt. In addition, this case study raises issues pertaining to fraud and insolvency. Rule of Law The court case, Salomon vs. Salomon & Co Ltd touches on major legal issues evident in this case study1. This case is considered to be a landmark case that set precedent for the modern company law. In this case, the High Court held that despite the fact that Mr. Salomon was the majority shareholder, managing director and the main controller of Slowgo Pty Ltd, the company was operating in its own right thus it is separate from its controller or majority shareholder. Therefore, the creditors could not recover their debts since their contract was with the company and not Salomon. Nevertheless, the Court of Appeal held that since Salomon was the majority shareholder and also the director and main controller of Slowgo Pty Ltd, the company belonged to him. Therefore, he should be liable to pay the company owes to its creditors. However on further appeal, the court held that since Slowgo Pty Ltd had complied with all the incorporation requirements provided in S18 of the Companies Act 1862, it is a separate entity from Salomon2. Similarly, in Lee v Lee’s Air Farming Ltd the court affirmed that Lee’s Air Farming Ltd was a separate entity from George Lee, the director and the major shareholder. Therefore, the director should be considered to be under an employment contract in the company3. Application In reference to Salomon v Salomon & Co Ltd and Lee v Lee’s Air Farming Ltd we can argue that, since Slowgo Pty Ltd is a company limited by liability, all the debts incurred by the company are the liability of the company and not the liability directors or shareholders. In case, Slowgo Pty Ltd fully complied with incorporation requirements established under the Company Act, it therefore exist a separate legal entity from the directors and shareholders. This means that the debts incurred by the company are liable to the company and not to the shareholders or directors. Therefore, if this case was to be used as precedence, the creditors may not be successful in sueing Simon personally4. Nevertheless, despite of lacking adequate legal grounds to sue Simon personally, certain legal issues regarding fraud and insolvency may also be pertinent in this court case. Under S 588G of the Corporations Act 2001, the director of a company may be found liable for failing to prevent a company from incurring debt or trading while the company is solvent5. Section 588G(2) particularly provides that by failing to prevent a company from incurring debt, the director can be found liable if he was aware or suspected that the company would fail to pay its creditors6. Therefore in reference to this provision, we can argue that Simon can be found liable for failure to preventing Slowgo Pty Ltd from incurring debt if he was aware or suspected that the company would not be in a position to pay its creditors. If found liable, he could be subjected to civil penalties provided under subsection 1317E (1)7. Moreover, under Section 588G (3), Simon can be found liable for committing a fraud if it is proved that he incurred debts while the company was insolvent or heading towards insolvency. Since under Simon’s control the company incurred debts that supersede the company’s assets, the creditors may have a strong legal grounds to sue him for fraud8. Conclusion It may be difficult for the creditors to sue Simon personally for the debts he incurred while operating as the nagging director of Slowgo Pty Ltd. Nevertheless, under Section 588G (2) and (3), the creditors may have strong legal grounds to sue Simon for incurring debts while the company was insolvent or heading towards insolvency. Question 2 Key Issues Ace, Brenda, Chris and Deidre have incorporated their shoe retailing business so as to get the benefits of the limited liability company model. In future they wish to raise capital by selling shares of their companies to the public. Rule of Law Types of companies Under S 112 of the Corporations Act 2001, there are two broad categories of companies namely; proprietary and public companies. Proprietary companies can be further classified into limited by share and unlimited with share capital companies. On the other hand, public companies can be classified into; limited by shares companies, limited by guarantee companies, unlimited with share capital companies and no liability companies9. 1. Proprietary Companies Under S 45 of the Corporations Act, a proprietary company is a form of registered private company. According to this Act, proprietary companies have certain restrictions. Firstly, these companies are required to only have a maximum of 50 members. Secondly, these companies are not permitted to engage in fundraising that involve the disclosure of documents that show fincancial statement or profile statement (s 133 (3).). Moreover, these companies are not permitted to raise funds by offering their shares to the public. Under S 45 A, proprietary companies can be classified as either large or small proprietary depending on their operating revenue, number of employees and their overall gross assets. Under this Act, proprietary companies can either be Proprietary Limited (Pty Ltd) or unlimited Proprietary (Pty). In proprietary limited companies limited by shares shareholders have more protection in case of liability particularly those involving company debt. However, in unlimited proprietary by share capital, the liability of shareholders is not limited. In case the four partners decide to establish their business as a proprietary limited company they are likely to enjoy some benefits. For instance, the liability of their company debts will be limited. This means that their business will exist as a separate legal entity from the directors and shareholders. Therefore, the debts incurred by the company will be liable to the company and not to the shareholders or directors. However, if they establish their business as a proprietary unlimited company by share capital, their liability may not be limited. Hence, debts incurred by the company may be liable to the four partners. Moreover, in case the four partners decide to establish their business as a proprietary limited company it will be easy for them to transfer ownership of the company through the sale of shares. They may also be afforded fixed tax rates. Although there are certain benefits that Ace, Brenda, Chris and Deidre are likely to enjoy if they establish their business as a proprietary limited or unlimited company, there are also certain disadvantages associated with this model. For instance, if they establish their company as a proprietary limited company they may not be able to raise capital by selling shares of their companies to the public. The growth of the company is restricted since they are not permitted to have more than 50 share holders. Secondly, proprietary limited companies are highly regulated under the Corporations Act and the Australian Securities and Investment Commission (ASIC). Therefore, it may not be suitable for these four business partners to establish their business as a proprietary limited or unlimited company. 2. Public Companies Under the Corporations Act, a public company is considered to be a company that issues and trades its securities in at least one stock exchange market. In case the four partners decide to establish their business as a public company they are likely to enjoy more advantages than if they establish their company as a proprietary limited or unlimited company. For instance, they will have greater accessibility to capital through the sale of shares to the public and access to debt markets. Their business is also likely to enjoy greater liquidity and considered to be credible by the public. However, in as much as there are significant advantages associated with public companies, they are also highly regulated. Furthermore, as founders of their business they will have less control since stakeholders must be involved in decision making. Once a company goes public, managers or directors have to answer to shareholders10. Application The four partners of the shoe retailing business should establish their business as a public limited company. This is because the public company offers conditions that are suitable for their demands. A public limited company is permitted under law to offers its bonds and shares to the public, through stock exchange schemes in order to raise capital. By establishing their company as public company they can also be able to realise a higher rate of profit return, they are able to enjoy a flat rate VAT as members. The four partners will also be able to expand their shoe retailing business more easily than if they establish their company as a proprietary limited company. Public companies can have as a many shareholders as they can accommodate while propriety limited companies can have a maximum of 50 shareholders. This makes it easy for public companies to raise capital and boost their liquidity. As a result, they can be able to expand and grow their business more easily than if they establish their business as a private entity. By establishing their company as a public company they can also be able to boost the image of their company since public companies are often considered to be credible by the public. Conclusion Ace, Brenda, Chris and Deidre should establish their business as a public limited company. This is mainly because a public limited model is in tandem with their future aspirations and goals which mainly involve raising capital through the sale of shares to the public. Therefore, by establishing their company as a public entity will enable these business partners to grow and expand their business more easily than if they establish their company as a propriety limited company. Works Cited Companies Act 1862 Corporations Act 2001 Lee v Lee’s Air Farming Ltd [1961] UKPC 33, [1961] AC 12 Puig, Gonzalo. “A Two-Edged Sword: Solomon and the Separate Legal Entity Doctrine”. Murdoch University Electronic Journal of Law 7. 3 (2000): Web April 10 2014. Salomon v A Salomon & Co Ltd [1897] AC 22 Read More