Salomon v Salomon Case Summary PDF

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Salomon v Salomon - Case Summary Incorporation is a cornerstone of modern company law. The consequences stemming from incorporation are often highly beneficial for those associated in carrying on a business. There are three methods by which a business can be incorporated; through Royal Charter; an Act of Parliament; and by Registration with a public body. 1 For the purposes of this case note, one shall be considering the latter of the three methods of incorporation; registration. The main consequence of incorporation is that, once all the relevant procedural requirements have been complied with, the company itself acquires a personality, recognised in law, separate from its members. 2 This means that a company will have the capacity to enter into binding agreements with third parties through the acts of its agents.

Incorporation by registration gained popularity in the late nineteenth century. Many businesses which once carried on as sole-proprietorships or partnerships gradually decided to incorporate by registration. However, the fundamental importance of incorporation was not fully recognised until the House of Lords decision in Salomon v A Salomon and Co Ltd3 (Salomon).

Aaron Salomon was a sole trader carrying on business as a successful boot maker. In 1892 Mr Salomon decided to form a company and ‘A. Salomon & Co Ltd’ (the company) was registered under the Companies Act 1862 (CA 1862). Mr Salomon, his wife, and their five children became shareholders, each subscribing to one share, with Mr Salomon and his two sons named as directors.

Once the company was formally incorporated, he then sold his boot-making business to the company at the price of £39,000. The company paid for the business through allotting Mr Salomon with 20,000 £1 shares, the remaining amount was accounted for by issuing Mr Salomon £10,000 in debentures. The company gave Mr Salomon security for the debentures by granting him a floating charge over the company’s stock-in-trade. 1 Mayson, French & Ryan, Company Law (23nd Edn, OUP 2015) 7. 2 Ibid p126 3 Salomon v A Salomon and Co Ltd [1897] AC 22.

Soon after incorporation, the company became insolvent and entered into liquidation. The company owed £7,773 to its unsecured creditors, however upon realisation of the company’s assets there remained only £1,055 available for distribution. As a creditor to the Company, Mr Salomon claimed that he was entitled to the £1,055 as he held security in consideration for his debentures. Being a security holder, if Mr Salomon were successful in enforcing his floating charge, he would take priority over the company’s unsecured creditors, leaving them with nothing.

The Company’s liquidator, Mr Brodrip, stood on behalf of the company’s creditors and denied Mr Salomon’s claim. He suggested: 1. the price the company paid for the business was excessive and 2. the formation of the company constituted as a ‘fraud to the creditors’4. For these reasons, he claimed that Mr Salomon should be responsible for satisfying the Company’s debts, just as he would if he had remained a sole trader. At the court of First Instance, (Brodrip v Salomon5) Vaughan Williams J. (Williams) did not accept Mr Brodrip’s claims. Alternatively he found that the company had conducted business as an agent for Mr Salomon, making Mr Salomon himself the principle. Williams found the members of the company to be mere ‘dummies’ 6 and the company was just Mr Salomon ‘in another form’. Williams held Mr Salomon to be personally liable to indemnify the creditors for ‘all the debts incurred in the course of agency for him’7. Mr Salomon appealed. The Court of Appeal (Broderip v Salomon8) upheld the High Court’s decision, but not on the grounds presented by Williams. In his judgement, Lindley LJ. (Lindley) acknowledged the importance and consequences flowing from a valid incorporation. He suggested that as the formalities of the CA 1862 had been formally complied with, and the company should ‘be regarded as a corporation, but as a corporation created for an illegitimate purpose’ 9. On this basis Lindley held that Salomon used the CA 4 Brodrip v Salomon [1893] B 4793 5 [1893] B 4793 6 ibid, Williams J. 7 Broderip v Salomon [1895] 2 ch 323 8 ibid 9 ibid

1862 as a ‘device to defraud creditors.’ 10 He recognised that as a result of valid incorporation, the company’s creditors were unable to sue Mr Solomon directly and ‘could only reach him through the company’ 11, he therefore held that Mr Solomon would be liable for indemnifying the company and held this to be ‘the legal consequence of the formation of the company in order to attain a result not permitted by law’12.

Lopes LJ. (Lopes) judgement concurred with Lindley, but went further and grounded his own judgement on the identity of the members of the company. Agreeing with Lindley, Lopes found that there was a valid incorporation, however he held that it was inconsistent with and opposed to policy and provisions of CA 186213. Differing from Lindley’s judgement, Lopes took a more purposive approach and claimed that the ‘Act contemplated the incorporation of seven independent bona fide members’ 14 and not ‘one substantial person and six mere dummies’15. He suggested that the other six members of the company (Mrs Salomon and their five children) were ‘mere puppets’ of Mr Salomon who adopted the machinery of the Act to carry on business in the manner of a sole trader.

Kay LJ.’s (Kay), judgement followed similar reasoning as Lopes, however, he took the purposive approach further and dissented from the view that there was a valid incorporation. He echoed Lopes judgement in regards to bona fide members and claimed that parliament did not ‘intend to legalise a pretend association for the purpose of an individual carrying on his own business with the limited liability’ 16 granted to him from valid registration under CA 1862. On this basis, Kay suggested the court should find the sale of Mr Salomon’s business to the company invalid and should be set aside resulting with Mr Salomon being made to indemnify the company for the cost of sale and the interest of the debentures 17, as well as the debts incurred by the company. Kay thus agreed with order of relief by Lindley, holding Mr Salomon 10 ibid 339 11 ibid 340 12 ibid 338 13 ibid 341 14 ibid 15 ibid 16 ibid 345 17 ibid 347

liable to indemnify the company, however his reasoning as to the extent of his liability differed. Mr Salomon appealed. The House of Lords (Aron Salomon v A Salomon & Co Ltd 18) rejected the arguments of agency or fraud and allowed Mr Salomon’s appeal. In his opening judgement, Lord Halsbury posed the question for consideration by the House, as to ‘whether the respondent company was a company at all – whether in truth that the artificial creation of the Legislature had been validly constituted’ 19. Unlike the judgements of the appeals court, Lord Halsbury held that he had ‘no right to add to the requirements of the statute’ and stated to the house that ‘the sole guide must be the statute itself’ 20, although the merits of the pervious judgments were discussed, the approach proposed in Lord Halsbury’s opening judgement became the basis of all the Law Lords Judgements.

The CA 1862 required seven members holding at least one share each, it was silent as to the shareholders being independent, or for there to be a specific balance of power within the company’s internal relations. Based upon the literal reading of CA 1862, the Lords unanimously decided that the company had been validly brought into existence and found the business to belong to the company, and not to Mr Salomon; dismissing any prior argument of agency, trusteeship or fraud. The House affirmed the extent of the consequences flowing from a valid incorporation under CA 1862. Confirming that the company was a separate legal entity to Mr Salomon, thus Mr Salomon was not liable for the debts and liabilities incurred by the company.

The decision in Salomon is sometimes said to have established the concept of separate legal personality. This is untrue, the idea of bringing a legal person into existence through registration was established prior to 1897 with the Joint Stock Companies Act 1844. Salomon demonstrated that the courts had not, until then, fully appreciated the consequences of incorporation and ‘separate legal personality’. It established that the court would not call into question the validity of incorporation through registration where all the formalities have been complied with, even if the consequence of 18 [1897] AC 22 19 ibid 30 20 ibid

incorporation would be to shield the owner(s) from the liabilities incurred through carrying on business, known as the ‘veil of incorporation’. Further, there were two other innovative principles established by the House of Lords in Salomon. Firstly, Salomon covertly recognised the ‘one-man company’ long before the legislator overtly allowed their creation in 1992 21. Secondly, a relationship of agency or trust will not be inferred on the basis of a person holding shares in a company.

21 Companies (Single Member Private Limited Companies) Regulations 1992

Bibliography

Legislation Companies Act 1862 Joint Stock Companies Act 1844

Cases Brodrip v Salomon [1893] B 4793 Brodrip v Salomon [1895] 2 Salomon v A Salomon and Co Ltd [1897] AC 22

Books Mayson, French & Ryan, Company Law (23nd Edn, OUP 2015)...