CRITICAL ESSAY

SALOMON V. SALOMON& CO. LTD.

 Introduction

A company is a form of business. According to Justice Buckley, the word ‘company’ has no
strictly technical or legal meaning.1Section 2(20) of the Companies Act, 2013 defines
‘company’ as a business entity registered under the current Act of 2013, or any of the
previous Companies Acts. In common law a company is a ‘legal person’ or ‘legal entity’
separate from, and capable of surviving beyond the lives of its members.2Gray defines
‘person’ as:3

“An entity to which rights and duties may be attributed; any being that is capable of holding
a right or duty, whether it being a human or not is person in law.”

Like any juristic person, a company is a legal entity apart from its members, it is capable of
rights and duties of its own, and endowed with the potential of perpetual succession.4One of
the important features of a company is its legal character. A company is a Special Legal
Personality (SLP) or basically, an artificial person, in whose name businesses or transactions
can be carried out. Section 9 of the Companies Act, 2013 states the provision of ‘Independent
Corporate Existence.’ However, a company has to be registered or incorporated to make it
into a separate legal entity. Special Legal Personality (SLP) is the basic principle on which
company law is premised. This tenet, being the most profound and steady rule of corporate
jurisprudence, establishes the foundation of how a company exists and functions.
Nevertheless, this principle, established in the case of Saloman v. Saloman, is conventionally
celebrated as forming the core of not only the English company law, but also of the universal
commercial law regime. In this critical essay, we will explore on the following statement
made by Lord Halsbury L.C. in Salomon’s case and analyse the court’s approach to the
separate legal entity principle.

1
Stanley re, (1906) 1 Ch 131, 134.
2
Salomon v. Salomon & Co., [1896] UKHL 1 : [1897] AC 22.
3
DR. N.V. PARANJAPE, STUDIES IN JURISPRUDENCE LEGAL THEORY, (5 thed.).
4
HAHLO AND TREBILCOCK, HAHLO’S CASEBOOK ON COMPANY LAW, 42 (2 nded.).
“Either the limited company was a legal entity or it was not. If it was, the business belonged
to it and not to Mr. Salomon. If it was not, there was no person and nothing to be an agent at
all; and it is impossible to say at the same time that there is a company and there is not”

 Facts of the case

The present case is about successful leather merchant, Aaron Salomon who specialised in
manufacturing leather boots. Initially, he ran his business as a sole proprietor. By 1892, his
sons became interested in the business and wanted to become partners, so Salomon decided
to incorporate his business into a limited liability company, Salomon & Co. Ltd.

At that time the legal prerequisite for incorporation was that at least seven persons should
subscribe as members of the company that is, as shareholders. Mr. Salomon, being the
managing director of the company, owned 20,001 of the company’s 20,007 shares and the
remaining six were shared individually between the other six shareholders (wife, daughter
and four sons). His wife and five children became the subscribers and the two elder sons
became the directors of the company. However, the company was a one-man business, since
Salomon was the nominee, holding majority of the shares. The price for such transfer was
paid to Salomon by way of shares, and debentures having a floating charge on the assets of
the company. He sold his business to the new corporation for almost £39,000, of which
£10,000 was a debt to him. He was thus, the company’s principal shareholder and its
principal creditor at the same time. In payment, Salomon took 20,000 shares of £1 each and
debentures worth £10,000. These debentures certified that the company owed Salomon
£10,000 and created a charge on the company’s assets.

Soon after the business had been incorporated, the shoe industry witnessed a series of strikes.
The government then decided to split contracts with several firms with the aim of
diversifying and reducing the risk of its few suppliers, due to the ongoing strikes. Since the
company was in need of funds they sought £5,000 from Broderip. Salomon’s debenture was
then assigned to Broderip and secured by a floating charge. In the end, however, the
company’s business failed and Broderip sued to enforce his security.

When the company’s business failed, it went into liquidation. On winding up, the state of
affairs was something like this – Assets £6,000; Liabilities – Salomon as debenture holder-

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£10,000 and unsecured creditors £7,000. Thus paying of the debenture holder nothing would
be left for the unsecured creditors.

The Liquidator argued that the company was a sham and a mere agent for Salomon. The
assets of the company were not sufficient to discharge the debentures (held entirely by
Salomon himself). Nothing was left for the unsecured creditors, who contended that, the
company, though incorporated under the Act, never had an independent existence. It was in
fact his agent, him being the managing director, and the other directors being his sons and
under his control. The Liquidator said that Salomon, being the principal, was personally
liable for his debt. In short, the Liquidator overlooked the separate personality of the
corporation Salomon & Co. Ltd., and made Mr. Salomon personally liable for the company’s
debt as if he was the sole trader of the business.

 Issue before the Court

The present matter concerned the claims of certain unsecured creditors in the liquidation
process of Salomon & Co. Ltd. The issue before the Court was whether, regardless of the
separate legal identity of a company, a shareholder/ controller could be held liable for its
debt, over and above the capital contribution, so as to expose such a member to unlimited
personal liability.

 Ruling

The Court of Appeal, declared the ‘company’ to be a myth and agreed with the contentions of
the unsecured creditors and the Liquidator. It reasoned that Salomon had incorporated the
company contrary to the true intent of the then Companies Act, 1862, and that it had
conducted business as an agent of Salomon who should be solely responsible for the debt
incurred in the course of such agency.

On appeal, the House of Lords, reversed the above ruling and held that, as the company was
duly incorporated, it is an independent person with rights and liabilities for itself. It was also
ruled that the motives of those who took part in the promotion of the company are absolutely
irrelevant in discussing what those rights and liabilities are.5Thus, the legal fiction of

5Gas Lighting Improvement Co. Ltd. v. Commissioners of Inland Revenue, 1923 AC 723.

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‘corporate veil’ between the company and its owners/ controllers6 was firmly created by the
Salomon case.

 Analysis

The outstanding feature of a company is its independent corporate existence. A ‘company’ is

a distinct legal persona existing independent of its members.7 In the present case, their
Lordships of the House of Lords observed:

“When the memorandum is duly signed and registered though there be only seven shares
taken, the subscribers are a body corporate capable forthwith of exercising all the functions
of an incorporated company. It is difficult to understand how a body corporate thus created
by statute can lose its individuality by issuing the bulk of its capital to one person.”

It was also observed by Lord Macnaughtenthat a ‘company’ is at law a different person

altogether from the subscribers/ shareholders of the memorandum; and though it may be that
the business after incorporation is precisely the same as before, the company is not in law the
trustee or agent of the subscribers. Also, the statute enacts nothing as to the extent or the
degree of interest which may be held by each of the seven, or the proportion of interest or
influence possessed by one or majority of the shareholders over the others. Lord Halsbury
L.C., in the present judgement also observed that:

“….I am simply here dealing with the provisions of the statute, and it seems to be essential to
the artificial creation that the law should recognise only that artificial existence quite apart
from the motives or conduct of individual corporators...”

Thus, the ‘company’ is a business entity with a distinct legal character, and is separate from
itssubscribers/ shareholders. This principle of separate legal personality had been
recognized in India even before the Salomon case.

In the case of Kondoli Tea Co. Ltd., re,8 certain persons transferred a tea estate to a company
and claimed exemptions from ad valorem duty stating that they themselves were the
shareholders in the company, and therefore, it was nothing but a transfer from them in one to
themselves under another name. However, the Calcutta High Court rejected this contention
and observed that that company was a separate person, and a separate body altogether from

6
Jennings v Crown Prosecution Service, 2008 UKHL 29.
7
AVTAR SINGH, COMPANY LAW, 4 (16th ed., 2015).
8
ILR (1886) 13 Cal 43.

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its shareholders and that the transfer was a transfer in property, as if the shareholders had
been totally different persons.

The Bombay High Court, with reference to one-man companies, similar to the Salomon type,
observed:9

“Under the law, an incorporated company is a distinct entity, and although all the shares
may be practically controlled by one person, in law a company is a distinct entity and it is not
permissible or relevant to enquire whether the directors belonged to the same family or
whether it is, an compendiously described, a ‘one-man company’.”

Hence, one-man companies exist with the backing of the legislature, and “the great majority
of them are as bona fide and genuine as in a business sense they are convenient and suitable
media for provision and application of capital to industry.”10

The House of Lords laid down the following basic principles of a company:

(1) Artificial Person

The company is a juristic person, however, it is not regarded as a natural person. It exists only
under law. It is represented by natural persons, such as, Directors, Managers, Officers and
Shareholders to name a few. These persons are responsible for the day to day management of
the company. Nevertheless, these individuals only represent the company and behave within
the scope of authority conferred on them by the company.

(2) Limited Liability

In case of a limited liability company, the members/ shareholders are only liable to contribute
towards payments of its debts to a limited extent. The liability of the shareholders is
measured with respect to the value of shares they hold in the company and nothing more than
that. However, in the case of unlimited liability, the members are held liable till the whole
amount has been paid off. If a company is unable to pay the debts, the creditors may choose
to wind up the company.

These principles have been endorsed in the case of Lee v. Lee’s Air Farming Ltd.,11where a
certain man called Lee was the managing director of a company he incorporated. In that

9
T R Pratt (Bombay) Ltd. v. ED Sasoon& Co. Ltd., AIR 1936 Bom 62 ; Praga Tools Corpn v. CA Imanual,
(1969) 1 SCC 585 : AIR 1969 SC 1306.
10
Commr of Inland Revenue v. Sansom, (1921) 2 KB 492 : 125 LT 37.
11
1961 AC 12 : (1960) 3 WLR 758.

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capacity he appointed himself as the pilot, making him an employee of the Company at the
same time. While flying the plane, he died in an accident. His widow asked for compensation
under the Workman’s Compensation Act.

“In effect the magic of corporate personality enabled him to be master and servant at the
same time.”12

Where the total number of directors and shareholders consent to the misuse of the company’s
money, they can be prosecuted for theft because the consent of the whole number may not be
the consent of the company.13In the case of R v. Phillippou,14 a director’s personal telephone
was not allowed to be disconnected for the company’s default in payment. In another case, it
was held that the Managing Director cannot be compelled in his personal capacity to produce
books of which he has custody in official capacity.15

 Criticisms and exceptions

Salomon’s case has met with considerable criticism. Much of the criticism has been based on
the fact that the concept of ‘corporate veil’ may at times lead to injustice. For instance,
Kahn-Freund described the decision made in Salomon’s case as “calamitous”.16 He further
called for the abolition of private companies.

Disapproval is also mounted against Salomon’s case on the basis that priority is given to the
separate identity principle over the economic reality of a one-person company. In the
article, The Law Quarterly Review, Goulding elucidates that criticism rested against
Salomon’s case is two-fold. First, the unanimous ruling made by the House of Lords in this
case gives incorporators the benefit of limited liability even in situations where it may be
deemed unnecessary. Second, this decision affords unscrupulous promoters opportunities to
abuse the privileges provided for under the Corporations Act.

The case of Salomon v. Salomon & Co. Ltd., established the concept of the Veil of
Incorporation. Nonetheless, this principle is now restricted in its application to ensure that
liability for tax is not being avoided. The veil of incorporation may be disregarded only in
certain circumstances. In Re a Company,17 the Court held that it would use its powers to

12
GOWER, GENERAL PRINCIPLES OF MODERN COMPANY LAW, 202 (3 rd ed., 1969).
13
Attorney-General’s Reference (No. 2 of 1983), 1984 QB 456 : (1984) WLR 465 (CA).
14
(1989) 5 BCC 665.
15
SAK ChinnathambiChettiar v. GS Murugan, (1968) 38 Comp Cas772 : (1968) 2 Comp LJ 260 (Mad).
16
7 MODERN LAW REVIEW 54.
17
[1985] BCLC 333.

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pierce the corporate veil if it felt it was necessary to prevent an injustice. The Court can
pierce this veil of incorporation by a specific provision in the legislation or by their
discretion. The three main reasons why the veil may be lifted are as follows:

(1) To enforce the provisions of the Companies Act

(2) To avoid fraud
(3) To deal with a group of companies

The chief advantage of incorporation is its separate legal personality. However, in reality, the
business of the artificial person is always carried out by and for the benefit of some human
individuals. It was noted in the case of Gallagher v. Germania Brewing Co.,18

“…by fiction of law, a corporation is a distinct entity, yet in reality, it is an association of

persons who are in fact the beneficiaries of corporate property”

In the case of Charanjit Lal Chowdhury v. Union of India,19 the Supreme Court did not allow
a shareholder to sue for the violation of the fundamental rights of his company.

The decision given in the Salomon’s case provides an ideal vehicle for fraud. Nowadays, the
form of corporation has been mistreated for the growth of many different forms of fraudulent
or anti-social activity. For instance, in Jones v. Lipman,20 the defendant contracted to sell
land and later tried to get out of this by conveying the land to a company he had formed for
this express purpose. Nevertheless, the court held that his company was 'cloak' or 'sham' and
lifted the corporate veil, ordering specific performance of the contract.The Courts will refuse
to uphold the separate existence of a company where it is formed to defeat or circumvent law,
to defraud creditors or to avoid legal obligations.21Courts have been known to lift the veil to
achieve justice. For example, in Creasey v. Beachwood Motors,22 the Judge lifted the
corporate veil in the interests of justice. This exception is very wide and uncertain, depending
on the facts of each individual case.When there is a danger to public interest, where the
parent company is committing fraud through its subsidiary company, the Court has made the
parent company resposible even though the entire unit is a separate entity in itself.23

18
53 Minn214 : 54 NW 1115 (1893).
19
AIR 1951 SC 1 : 1950 SCR 869.
20
1962 1WLR 832 (Ch).
21
Gilford Motor Co. Ltd. v. Horne, 1933 Ch 935 (CA) ;Conners Bros Ltd. v. Conners, (1940) 4 All ER 179
(PC).
22
1993 BCLC 480 (QB).
23
Daimler and Co. Ltd. v. Continental Tyre & Rubber Co. Ltd., (1916) 2 AC 307 : (1916-17) All ER Rep 191
(HL).

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  Conclusion

Lord Denning MR said in a case,24

“The doctrine laid down in Salomon’s case has to be watched carefully. It has often been
supposed to cast a veil over the personality of a limited company through which the courts
cannot see. But that is not true. The Courts can and often do set aside the veil.”

Thus, in the light of the above discussion, it may be concluded that, even though it is firmly
established ever since Solomon’s case that a company is an independent and legal personality
distinct from the individuals who are its members, it has since been held that the corporate
veil may be lifted, the corporate personality may be ignored and the individual members
recognized for who they are in certain exceptional circumstances. Generally, and broadly
speaking the corporate veil may be lifted where the statute itself contemplates lifting the veil
or fraud, or improper conduct is intended to be prevented. The lifting of the veil will depend
on the facts and circumstances of each case.

24
Littlewoods Mail Order Stores Ltd. v. IRC, (1969) 1 WLR 1241 : (1969) 3 All ER 855 (CA).

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