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Introduction to Case
A business enterprise can be broadly divided into two broad categories, namely, one which is non-corporate in form and the other which has a corporate character. The former includes sole proprietorship, partnership, and HUF while a company and other co-operative undertakings fall in the latter category. Since every business is profit motive, it is especially important to carefully choose the type of business. A company has many advantages over other types of business; the most important one is that the company have a “separate corporate personality”. This characteristic enables the member of the firm in different ways. The first case which established this characteristic of a company is Salomon v. Salomon Co Ltd,[1] which we will be discussing in detail in this article.
Facts of Case
Aron Salomon was a leather shoe manufacturer. He established a company in 1892 so as to make his children, partners in his business. He turned his business into a limited liability company, where his wife and five elder children became the shareholders and two of them became the directors as well. Out of the 20,007 shares, Mr Salomon held 20,001 shares and the rest were held by the other six shareholders equally. He also held debentures worth Euro 9000, thus his liability in the company became limited. Also, as the MD he secured himself a secured charge over the company’s assets. But soon, the business ran into debt due to decline in the boot business, defaulting interest in payments on debentures, half of which was held by Mr Edmund Broderip and he instituted an action for holding Mr Salomon personally liable.
Issue
- Whether Mr Salomon abused the separate legal personality of the company to defraud debenture holders and whether he was personally liable?
Judgment
The House of Lords overruled the decision of High Court. The ratio of the case as pronounced by Lord Macnaghten who emphasised that the company under law is a different person from the subscribers to the MOA. He disagreed to the view of court of appeal that company is an agent of its subscribers; thus, the subscribers as members are not liable, except to the extent and in the manner provided by the Act. No common law partnership could register as a company limited by shares without remaining subject to unlimited liability.
Analysis of Case
Professor Haney defines a Company as “an artificial person created by law, having separate entity with a perpetual succession and common seal.” This definition encompasses every characteristic of a company. A Company is created by law, thus having a separate legal personality (SLP) with rights and liabilities different from that of its members. Perpetual succession implies the ability of a company to exist even when the old members cease to be in the company, by enabling the succession of new members. In short, “members may come and go, but the company can go on forever”. Sec. 7 of Companies Act (CA), 2013 explains incorporation of company which has to be filed with the ROC under whose jurisdiction, the registered office of the company is situated. After the incorporation in compliance with the provisions, a company becomes an artificial person, distinct from its members or shareholders.
Section 9 of CA explains the effect of registration. From the date of incorporation, the company shall become a body corporate identified and can sue or be sued upon in the name which is specified in the Memorandum of Association (MOA). It can perform all the functions mentioned under the Act and has perpetual succession. It can also acquire, hold, and dispose of both movable and immovable property as well as tangible and intangible property.
This case concreted the doctrine of separate legal personality of a company; however, with exceptions evolved later. A company can hold and acquire properties in its own name, and it is not owned by the members which was later held in Macaura v Nothern Assurance Co Ltd.[2] Later, in Lee v Lee’s Air Farming[3], the deceased wife of the company’s owner was entitled to workmen’s compensation on the same principle. The Salomon case recognised the concept of a corporate personality and guaranteed the limited liability of shareholders, which are the pillars of Company Law. However, it was later criticised for allowing abuse of this status of a company by its members. Therefore, many exceptions were brough to the application of this principle.
As seen in the case, the concept of corporate veil has to be allowed for legitimate purposes only; a rigid application of the doctrine causes significant damages. The statutory privilege has to have direct connection with the business. Though law confers a company, separate legal personality, in reality it is an association of persons who are in fact beneficial owners of corporate property. In case Littlewoods Mail Order Stores Ltd V. Inland Revenue Commrs,[4] Lord Denning observed: “The doctrine laid down in case Salomon v. Salomon and Salomon Co.Ltd, has to be watched very carefully. It has often been supposed to cast a veil over the personality of a limited liability company through which the Courts cannot see. But that is not true. The Courts can and often do draw aside the veil. They can and often do, pull off the mask. They look to see what really lies behind”.
In case Prest v Petrodel Resources Ltd,[5] the court held that the principle should be given a narrow construction. One of the classic case laws for misuse of corporate personality and the court subsequently lifted the corporate veil is Gilford Motor Company Ltd v Horne[6]where the company was just a cloak.
Smith , Stone & Knight Ltd v Birmingham Corporation (SSK)[7] was a case which significantly differed with Salomon case. In this case, the company was owned as subsidiary company by Birmingham Waste Co Ltd. SSK owned some land, which the Birmingham Corporation ordered to pay. But BWC claimed that it was not liable to pay as the land was not possessed by it. The court in the case held that the subsidiary company was nothing an agent of BWC, therefore BWC is liable to pay. The court lifted the veil in order to identify the ownership of the business and land. Since there was no transfer of business by SSK to BWC, it has to be considered as an agent of the parent company.
Thus, for fraudulent and dishonest purposes if the privilege is used, such persons can be made personally liable for the debts of the company. Or when a person uses this for concealing his own criminal activities, the court will break through the corporate shell and apply the principle of what is known as “lifting or piercing through the corporate veil.”
Conclusion
Thus, the status of company being an artificial person is prime characteristic which protects its shareholders from being personally liable for its debts. This concept is called corporate veil. It was first established by the House of Lords in UK in this landmark case – Salomon v. Salomon Co Ltd.[8]
References:
[1] [1897] AC 22.
[2] [1925] AC 619.
[3] [1961] A.C. 12.
[4] [1969] 1 WLR 1241.
[5] [2013] UKSC 34.
[6] [1933] Ch 935.
[7] [1939] 4 All ER 116.
[8] [1897] AC 22.
