Salomon v salomon

IntroductionThis essay will examine the legal standing of the doctrine of ‘separate legal personality’ as it was developed in Salomon v. Salomon & Co Ltd [1897] AC 22. Even though this doctrine is the stone head of the English company common law, the courts introduced several exceptions which undermined the ‘veil of incorporation’.

The exceptions were firstly introduced in the mid-60s by Lord Denning in Littlewoods Mail Order Stores Ltd. V IRC [1969], and allowed the court to lift the veil and hold the shareholders liable for the company’s actions. The main reason for the courts to lift the veil is where the shareholders had abused the privileges of limited liability and incorporation.

Corporate personality and incorporationIncorporation is the procedure of stating a company as separate legal personality from its shareholders. At the time when a company is incorporated, it becomes a separate legal personality; namely it has legal existence in the eye of law. By corporate personality it is considered that the company has a different identification from its members and the members’ liability is extended only up to the amount they have to pay for their shares.

One of the main effects of limited liability is that the company carries its own contracts. The company’s creditors can take action only against the company even though sometimes they will not be able to retrieve their money back if the company is liquidated.

Furthermore, the company is not affected from the death or the decision of a member who withdraws. It might affect the functions of the company but it will still exist. A company owns its own assets. The assets belong to the company; the members have no rights over company’s property. This provides security to the creditors as the shareholders will not be able to extract the assets out of the company and reduce company’s value.

Salomon v Salomon .CoSalomon had a business as a sole trader and decided to enlarge it to a company called Salomon & Co Ltd. His family held from one share each and he held the remaining largest portion of shares. After the sale of the business, the company paid in return cash to Salomon and his family and debentures to Salomon in person. Soon the company faced financial problems and Mr. Salomon and another creditor had to lend the company money. Unfortunately the company came into liquidation and the liquidators supported that the debenture was invalid as Mr.

Salomon was a creditor of Salomon &Co Ltd; his own company. Even though the High Court held that the creditors allowed claiming against Mr. Salomon, the House of Lords held that the company was correctly incorporated; it was not relevant that the other members of the company had not as important part as him.

Thus Mr. Salomon and Salomon & Co Ltd were two different entities and the redemption of debentures was a priority. Salomon’s case was remarkable in extending the principle of separate personality. Even though after incorporation the company has the same nature it is a different legal person from its creators. The company is not an agent of its creator and he is no liable for the company unless it is provided by the Act.

The effect of the doctrine laid down in Salomon v SalomonThe Lords in the Salomon case stated that:

“The company is at law a different person altogether from the [shareholders] …; and, though it may be that after incorporation the business is precisely the same as it was before, and the same persons are managers, and the same hands received the profits, the company is not in law the agent of the [shareholders] or trustee for them. Nor are the [shareholders], as members, liable in any shape or form, except to the extent and in the manner provided for by the Act.”

Accordingly, it can be argued that Salomon case established the doctrine of ‘separate legal entity’ and ‘limited liability’. Once a company is lawfully incorporated, the members enjoy limited liability with no regard to several circumstances such as the number of the members and the fact that a member may be the only director or employee.

The most important effect of limited liability is that the shareholders are not liable for any debts as the company is a separate legal identity. In the case of bankruptcy, members’ personal assets are protected and out of reach by the company’s creditors. The Salomon case safeguarded member’s personal property and offered members a security as they can have earnings from the company while they are protected.

However, this protection offered by the Court to company’s members made the company’s creditors skeptical, since, in some cases the company was used to defraud the creditors and the state.

The courts had to balance the protection to shareholders and the injustice against the creditors. Accordingly, the courts had to be ready to ignore the doctrine of ‘separate legal personality’ and lift the veil of incorporation in cases where the company is incorporated in order to defraud.

Case of Littlewoods Mail Order Stores Ltd V Inland Revenue Commissioners and the statement of Lord Denning Lord Denning was the precursor of lifting the veil of incorporation. Specifically, in the case Littlewoods Mail Order Stores Ltd. V IRC [1969], Littlewoods rented premises on 99 year lease from Oddfellows, on a very low price (£23444).

Later the value of money changed and after 22 years Littlewoods and Oddfellows decided to find a way to both benefit. Oddfellows transferred the premises to Fork Manufacturing Co. Ltd., a wholly-owned subsidiary of Littlewoods. F.M let the premises to Oddfellows for 22 years and 10 days at £6 per year. The lease 99years lease was surrendered and Oddfellows became a lessee of the company for 22 years with rent £42450 per year.

Littlewoods appealed to the special commissioners against assessments to income tax supporting that tax benefits were associated with land acquired for subsidiary. The commissioners did not accept the appeals after detecting that the purpose of Littlewoods getting into contract was to ensure for its subsidiary the freehold reversion while maintaining occupation in the context of under lease. Hence, the £19006 was not an outcome of the company’s business and the deduction was forbidden by section by section 137 (a) and (f) of the Income Tax Act, 1952.1

The House of Lords held that he could not recognize the parent company and the subsidiary as one at the present case. Lord Denning supported that the courts have to be prepared to look behind a company and find the real purpose of its creation and operation. The court’s decision in Littlewoods case balanced the protection of the shareholders and the risk undertaken by company’s creditors.

The courts managed successfully to offer protection to creditors without opening the floodgates for actions against the innocent members. This was accomplished by carefully regulating and stating the ‘exceptions’ to the doctrine of ‘separate legal entity’ and ‘limited liability’.

Concept of lifting the corporate veil and the circumstances when the courts will apply this In some cases entrepreneurs try to take advantage of the veil of incorporation for deception purposes. Therefore, the courts may find that this liability protection should not apply and lift the corporate veil. This allows creditors to recover damages from the member’s personal assets if the corporate assets are not enough to compensate them. The lifting of corporate veil is adopted to prevent any violation of the incorporation and it targets only those responsible for the situation.

The veil can also be lifted when the defendant uses the company to evade any legal responsibilities (Jones v Lipman [1962] 1 All ER 442), when the company is a sham or facade and it is created for fraud. The relevant leading authority is Trustor AB Smallbone (No.2) [2001] 1 WRL 1177. The company was a sham and created as a ‘mask’ to help the transfer of money, it was involved in the impropriety and thus it was necessary to lift the veil for the purposes of justice. In general, the veil is lifted in cases where the company is used as a mask to mediate or hide the real reason of its creation.

A director cannot hide behind the representative liability of his company where he is fraudulent. According to the Insolvency Act 1986 under the section 213,214 a director is liable if in the case of liquidation of the company, it is discovered that the company carried on for fraudulent reasons. Moreover, he is also liable for wrongful trading if at that time knew or should have known that there was no reasonable possibility that the company would avoid going to liquidation.

When the director is deprived of his legal rights but still continues to act, then he will also be jointly and severally responsible for any liabilities and debts of the company. Additionally, the veil is lifted for the benefit of the nation or the community (Daimler Co. v Continental Tyro Co Ltd [1916] 2 AC 307). Finally, when the company equitable winds up; it is treated as a partnership even though there is no contract, when abuses legal procedures (Re Bugle Press [1961- Ch.270]) or if the company of a group does not fill a group account in conjunction with individual accounts then the ‘cape’ is lifted.

The circumstances of lifting the veil are not always straightforward and each case has to be examined individually.

ConclusionSalomon v Salomon established the corporate veil in English courts and it offered protection to the shareholders of the company. Despite this, the boundaries of this security have changed over the years. The courts tried to balance the protection of the shareholders and the risk faced by creditors of the company and accordingly the Littlewoods case established the first ‘exceptions’ to the general rule of limited liability.

This resulted to the fact that the members of the company sometimes may be equally and personally liable. Lifting the veil of incorporation, should be confined to the cases which the companies are used as masks for defraud. The veil should not be used wrongly, as, that will lead to arbitrary shield for those who want to divert the power of Company Law.

References1. (-). Corporate personality.Available: 2. Alan Dignam & John Lowry (-). Company Law. 5th ed. Oxford: Oxford UniversityPress. p18-23,32-39,47-49. 3. Ali Imanalin. (2011). C.S.L.R.. Rethinking limited  liability. 7 4. Anusuya Sadhi (-) Lifting The Corporate veil.

Available: 5. Judge, S. (2009) Business law. 4th ed., London: Palgave macmillan,p 148-154

CasesDaimler Co. v Continental Tyro Co Ltd [1916] 2 AC 307Jones v Lipman [1962] 1 All ER 442Littlewoods Mail Order Stores Ltd. V IRC [1969]Re Bugle Press [1961- Ch.270]Salomon v. Salomon & Co Ltd [1897] AC 22Trustor AB Smallbone (No.2) [2001] 1 WRL 1177

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