Salomon v. Salomon & Co. Ltd. case (1897)
The Salomon v. Salomon & Co. Ltd. case (1897) is a landmark decision in company law that established the doctrine of Separate Legal Personality (SLP), a fundamental principle stating that a corporation is a separate legal entity, distinct from its shareholders and directors. This principle has shaped the entire framework of company law, reinforcing that a properly incorporated company has its own legal identity. Here is an in-depth breakdown of the case.
Case Background and Facts
Aron Salomon was a successful leather merchant who operated his business as a sole trader. In 1892, he decided to convert his business into a limited liability company, Salomon & Co. Ltd., to enjoy the benefits of incorporation, such as limited liability and ease of succession. Under the Companies Act 1862, a minimum of seven members was required to form a company. To meet this requirement, Salomon included his wife, daughter, and four sons as shareholders, each holding one share, while Salomon held the majority, owning 20,001 of the total 20,007 shares.
The company purchased Salomon's business for £39,000, which was paid in three parts:
- £10,000 in debentures (secured loan against the company’s assets),
- £20,000 in fully paid-up shares,
- £9,000 in cash.
Salomon, as a secured debenture holder, had priority over unsecured creditors if the company failed. Soon after incorporation, however, Salomon & Co. Ltd. ran into financial difficulties due to a decline in business. Within a year, the company went into liquidation. By this time, the company’s assets were worth only £6,000, which could not cover its liabilities. After the debenture holders were paid their secured amount, there was nothing left to satisfy the claims of the unsecured creditors.
The liquidator filed a suit against Salomon, arguing that he should be held personally responsible for the company’s debts, claiming that Salomon & Co. Ltd. was a mere sham, created to protect Salomon’s personal assets from the business liabilities.
Legal Issues
The case revolved around three major legal issues:
- Separate Legal Existence: Did Salomon & Co. Ltd. exist as an independent legal entity?
- Corporate Veil: Was the company genuinely formed, or was it just a façade for Salomon’s personal business interests?
- Limited Liability: Could Salomon, as a shareholder and debenture holder, be held personally liable for the company’s debts?
Arguments Presented in Court
- Liquidator’s Argument: The liquidator contended that Salomon & Co. Ltd. was not a real company but merely an extension of Salomon himself. They argued that since Salomon controlled the company, it was a sham entity, created solely to shield him from personal liability.
- Salomon’s Defense: Salomon argued that Salomon & Co. Ltd. was a legally constituted company under the Companies Act 1862. He fulfilled all legal requirements for incorporation, including the seven-member rule, and thus, the company was a legitimate entity with a separate legal personality.
Judgement
The case was initially heard by the Court of Appeal, which ruled against Salomon, holding that the company was a mere "agent" or "trustee" for Salomon’s business interests. However, Salomon appealed to the House of Lords, which reversed the Court of Appeal's decision.
- Separate Legal Personality Doctrine: The House of Lords established that a company, once incorporated, has a legal existence separate from its shareholders. This meant that Salomon & Co. Ltd. was distinct from Aron Salomon and had its own rights and liabilities. This doctrine laid the foundation of the concept of Separate Legal Personality, a cornerstone of modern company law.
- Corporate Veil: The Lords held that the company was a legitimate corporation since it was formed according to the legal requirements. The idea of "lifting the corporate veil" was dismissed, as there was no evidence of fraud or improper conduct in the company’s formation. Salomon had the right to form a limited liability company, and the court would not interfere with his lawful exercise of this right.
- Limited Liability Protection: Since the company was a separate entity, Salomon was not personally liable for the company’s debts beyond his investment in shares. The court upheld the principle of limited liability, ruling that Salomon, as a secured debenture holder, was entitled to receive payment before unsecured creditors.