INTRODUCTION

In every Company Law book

Salomon v Salomon
1
is the case which is mostrecognised. The importance of this case lies in the fact that it establishes
that thecompany is a totally different person from its incorporators. It offers the limitedliability
not only as a business vehicle for partners, but for even traders who take thefull benefit of limited
liability.

In this term paper I will discuss the dictum derived from Lord Halsburys judgementin
Salomon v Salomon
what are the pros and cons of the dictum, the reasoning whythe House of Lords reached their
conclusion reversing what the Court of Appeal saidin relation to the agency point. The
assessment of the limited liability doctrine whichwas originally intended to encourage passive
investors to contribute to encouragetrade and commerce, the most fundamental criticism to this
doctrine, group of companies and when the court will lift the veil between the parent and its
subsidiary.A mention must be made of shareholders as the owners of the company and
creditorsinterest who lend the company money which directors have to take into
considerationwhen they are conducting the affairs of the company. What forms of protection
eitherunder Common Law or statute does the law offer to them? are these measures of protection
adequate?

At the end I will summarise what has been said previous and I will come up with aconclusion.

EXAMINING THE DICTUM

Before examining Lord Halsburys dictum in the House of Lords, it is useful to restatebriefly
what the Court of First Instance and the Court of Appeal said. The Court of First Instance and the
Court of Appeal thought that Salomon acted fraudulently whenhe held all the shares of his
family members who had no interest in the company andthat the formation of the company was
not done properly and Salomon would have toindemnify the companys creditors.

In response to the Court of Appeals judgement in

Broderip v Salmon
2
, Lord Halsbury
LC in
Salomon v Salomon
3
said Either the limited company was a legal entity or itwas not. If it was, the business belonged
to it and not to Mr Salomon. If it was not,there was no person and no thing to be an agent at all,
and it is impossible to say at thesame time that there is a company and there is not.

This dictum raises issues relating to the legal entity, the debts and assets of thecompany
(business), agency, and lifting the veil. I shall discuss every pointindividually.
A
The legal entity point
4

Lord Halsbury LC mentioned that Either the company was a legal entity or it wasnot. If we
look at this part of the dictum, we may at first sight say that it representsthe true
position. Whenever there is a company, there will be a legal entity associatedto it and it will have
a separate legal existence
5
from its incorporators, but is this all?or we must need in order to say there is a legal

entity a special procedure to be followed? and can we still say that the company has alegal entity
in the situation that fraud has been committed? Both judgement in theCourt of First Instance and
the Court of Appeal thought that Salomon had actedfraudulently. The House of Lords did not
find any form of fraud or deliberate abuseof the corporate form, on the contrary Salomon was a
victim in that he did his best torescue his company by cancelling the debenture he took and
raising them to anoutside creditor who provided fresh loan capital.
6
This honesty and good faith on thepart of Salomon prevented him from indemnifying the
company creditors. The Houseof Lords found there is a legal entity properly formed and there
was no use of liftingthe veil between Salomon and his company. Also another criticism lies in
the factthat not only the company is recognised as a separate legal entity but also according tothe
proposed legislation of the limited liability partnership which, amended a veryfundamental
concept in Partnership Law in England and gave the LLP a distinct legalentity from its partners
as a result the LLP will have most of the advantagesassociated with the company especially the
limited liability.
7
B The Business P
oint

Lord Halsbury said If it was, the business belonged to it and not to Mr Salomon.As a result of
the Court of Appeal refusal to recognise the existence of the legal entityand regarding the
company instead as a myth and fiction, they thought that thebusiness belonged to
Aron Salomon. Lord Halsbury refused that proposition. It issubmitted that this part of the dictum
is right as a consequence of the separatepersonality the company as soon as it is registered will
acquire all the assets which the

shareholders contributed to the company. The company will be regarded asconstituting its own
assets. For example, the property will no longer be members
joint property. Lord Wrenbury in
MaCaura
8
said My Lords, this appeal may be
disposed of by sayin
g that the corporator even if he holds all the shares is not thecorporation and that neither he nor
any creditors of the company has any propertylegal or equitable in the assets of the
corporation. Not only the assets will represent

19

company has acted fraudulently or dishonestly, and this provision will only come intoplace when
the company has gone into insolvent liquidation.

OTHER FORMS OF PROTECTING CREDITORS

A
Liability for acting while disqualified

Section 15 of the Directors Disqualification Act 1986 offers an important form

of protection. For creditors who can bring action directly against any person who is adirector or
being concerned directly or indirectly in taking part in the management of the company to be
liable for the debts of the company whether jointly or severallywith the company.

The importance of this provision lies in two respects. The company does not have tobe in
liquidation and creditors can enforce this provision directly without the need foraction by a
liquidator.

B
Unlimited liability of directors
56

According to Section 306, 307 of the Companies Act 1985, a limited company canintroduce a
clause originally in its memorandum or by way of alteration which statesthat the liability of its
directors should be unlimited in a winding
-
up procedure.Banks or other powerful investors might make this kind of provision as a requisite
forproviding their loans, although it must be noted that this provision is scarcely if everinvoked.

C
The use of the suffix limited

According to Section 25(2) of the Companies Act 1985 every limited company, eitherlimited by
share or by guarantee, is required to use the word limited Ltd or theWelsh equivalent after the
last word of its name stated in the memorandum.
57
Thisprovision can be said to be for the advantage of creditors and their disadvantage. Fortheir
advantage, since they are warned of the position of the company, shareholders
56
A J Boyle, Richard Sykes, Leonard Sealy,Gore
-
Browne on Companies
(Forth
-
fourth Edition), Vol2, Jordans, 1986

57
Ibid

20

will not be liable to contribute more than the assets they have advanced to theircompany. For
their disadvantage, since they cannot plead that they did not know theywere dealing with a
company, either limited by guarantee or shares. But what aboutthe situation when shareholders
deliberately conceal the exact position of theircompany? The laws answer to this point is that a
person or persons will be liable to afine or for continued contravention to a daily default fine.
58
In my opinion it issubmitted that this form of protection is not adequate enough especially
thecompensatory aspect of it, since it does not offer real protection for creditors.

Also it must be mentioned that there are other forms of protection, such as thedisclosure
requirement on the company, enabling third parties to make the companysearch the Companies
Registry. Creditors can take fixed or floating security to givethem priority in the situation that the
company has gone into insolvent liquidation.
And p
owerful creditors might employ several strategies to reduce the risks associatedwith debt
obligation by exercising some measure of control over the business affairsof the debtor company.

58
S 34 CA 1985

21

CONCLUSION
The House of Lords found that honesty and good faith on Salomons part preventedhim from
indemnifying the company creditors as they knew they were dealing with alegal person totally
different from his incorporators. Limited liability at that time wasalso available to sole traders
and large investors who wanted some form of limit ontheir undertakings.

The abuses which took place afterwards led some commentators to suggest abolishingthe limited
liability at all or at least to abolish the private companies, but what wouldbe the effect of that on
the commercial world? and are these abuses the exception orthe rule? It is submitted that
industry and trade will suffer as a result of manyinvestors not contributing more than the amount
they wish to invest, and we will beback at the beginning again. Traders will find a way to limit
their liability undercontract or insurance as they have done before.

Alteration of risk from shareholders to creditors and the abuse of the corporatepersonality and
the limited liability associated to it does not mean that the
limited
liability is of no good; many companies are prospering and flourishing without anyproblem and
these abuses are not the rule but the exception to it. The law startedrecognising the problem and
formed methods of protecting creditors, either preventiveor compensatory, preventive measures
requiring directors to take care of creditorsinterests and compensatory measures relating to
fraudulent and wrongful trading. Butare these measures of protection adequate? In my opinion I
do not think so, sincethey only enforced other provisions by a liquidator when the company was
inliquidation and this does not address the problem either.The judges also are not sure when to
lift the veil between the parent company and itssubsidiary only in exceptional circumstances will
declare shareholders liable to paythe debts when they use the company in case of fraud or to
evade legal obligation, butits a matter of the circumstances and there is no basic rule.