The company as a separate legal personality from that of its members as defined by the Companies Act 1862 was established in common law by the House of Lords in 1879 when they delivered their judgement in the case of Salomon v. Salomon & Co.
Ltd. Indeed, this case is now seminal, with both practitioners and students of the law referring to it as the foundation upon which modern company law is based. However, although the outcome of Salomon v Salomon & Co. Ltd is now firmly embedded that is not to say it has not been prone to the effects of the occasional tremor.
Since this ruling and some might argue prior to this ruling by the House of Lords questions relating to the interpretation of the act and its scope have been hotly debated. While some see this ruling as clearly interpreting the 1862 act at common law others contend that such an interpretation is too rigid and clearly open to abuse.
It would be argued that a separate legal personality in conjunction with limited liability offered the nineteenth century entrepreneur the protection they desperately needed if their business ventures were to grow and expand beyond their personal resources.
Others would contend that this ruling was to the detriment of the company’s creditors, allowing the unscrupulous individual or individuals to set up a limited company at little expense and little or no risk to themselves. Indeed, some detractors of the outcome of the Salomon v. Salomon & Co Ltd ruling have referred to such companies as a “sham”, “a screen” and “a mere fraud”.
These, and a plethora of similar terms illustrates perfectly, as Murray A. Pickering states, “the degree of uncertainty on the part of the courts on some occasions when dealing with the separate existence of the company”.
The uncertainty created by the House of Lords ruling between helping the entrepreneur and protecting the creditors of the business has seen that the principles of the company as a separate legal entity with limited liability not go unchallenged. Since 1879 companies have become more complex in their design and their operation and with out any radical changes in statute to incorporate these, it has been left largely to the courts to respond to these developments. The question of abuse by one or more individuals of the privileged status of the incorporated company has frequently come before the courts since the House of Lords ruling.
For instance the potential of a party or parties to operate behind a limited company and perpetrate a fraud upon the company’s creditors has been recognised and in recent decades the rise, and in some instances the dominance, of the group of companies (conglomerates and multinationals) has seen the courts set down a number of exceptions to the general principle of incorporation with its inherent benefits as laid down by the Companies Act 1862 as interpreted by the Salomon case. While Salomon v. Salomon & Co.
Ltd might form the foundations of modern company law, over the years those foundations have been made more pliable with the courts recognising a number of instances whereby the veil of incorporation can be lifted so as to allow the courts to determine the true nature of the organisation. Before one considers the potential for abuse of the rule as contained with in the Salomon v. Salomon & Co. Ltd case it would be prudent to begin by examining why the law in relation to the company needed to be changed.
The background surrounding the eventual House of Lords judgement will then be reviewed before consideration is given to the actual judgement itself. From this vantage point it will then be possible to consider in some detail the potential for abuse together with practical illustrations of how the courts and statute have sought reduce the potential for abuse. Prior to the 1840’s there were two routes available to someone seeking to create a company.
The first required the company to be incorporated by Royal Charter which in effect gave the company monopolistic power with in its sphere of influence (as defined by the charter). Indeed, during the seventeenth and eighteenth centuries this was the vehicle that allowed the British Empire to prosper. The other route was for a company to be incorporated by Parliament. However, this route was both time-consuming and expensive and could only be justified in the case of very large undertakings such as the development of the railway.
By the middle of the eighteenth century Britain was facing growing competition from its traditional European rivals (in particular France and Germany) and from the rapidly developing and industrialised United States of America. Indeed while the vast majority of Britain’s economic wealth rested in the hands of family run enterprises America was witnessing the creation of the conglomerate in the hands of such people as Andrew Carnegie (1835 – 1919) and J. P. Morgan (1837 – 1913).
While Britain had the skills and abilities to compete, the inability for an individual or a group of individuals to raise capital to create comparable enterprises was strangling economic development. It was common practice to insert provisions within the charter of a trading corporation which allowed ‘leviations’ on its members to pay the corporations debts, a factor which stifled entrepreneurial risk taking. Boyle and Bird in their book ‘Company Law’ credit the legislation of the 1840’s and the 1850’s as being responsible for the creation of the registered company that we can recognise today and while those commentating on the Salomon v.
Salomon & Co. Ltd case make reference in particular to the 1862 Companies Act one could argue, persuasively, that it was the Joint Stock Companies Acts of 1856, the that provides the bedrock upon which the modern company was formed. This act consolidated and reformed previous legislation. It introduced the memorandum and articles of association while abolishing deeds of settlement and of equal importance it removed previous safeguards for limited liability. These changes in the law were in response to a particular economic reality, the need to finance growth.
In conjunction with the skills of the entrepreneur and technological developments these changes helped to stimulate the economy by making it possible to raise capital for a business venture without facing the consequences of unlimited liability should the venture fail. Some thirty years later Mr Salomon, a manufacturer of boots and shoes and trading under the name ‘A Salomon & Co. ‘ sought to turn his business into a limited company. He adhered to all that was required of him under the Companies Act 1862.
However, the judge suggested that the company had a right of indemnity against Mr Salomon, declaring the shareholders of the company were nominees of Mr Salomon. The counter-claim was amended accordingly. Vaughan Williams J. declared that the plaintiffs of A. Salomon & Co, Limited or the liquidator were entitled to be indemnified by the defendant A. Salomon. It is interesting to note that his Lordship was attempting to lift the corporate veil, something that a number of courts have done against the backdrop of the House of Lords ruling on Salomon v.
Salomon & Co. Ltd in 1879. He stated “that this business was Mr Salomon’s business and no one else’s; that he chose to employ as agent a limited company; that he is bound to indemnify that agent, the company; and that his agent, the company, has a lien on the assets which overrides his claim” He went on to say “In this case it is clear that the relationship of principal and agent existed between Mr Salomon and the company. His Lordship had recognised and attempted to address what was to become one of the major exceptions (the company as an agent of an individual) to the Salomon v. Salomon & Co. Ltd ruling, one which would allow future courts to legitimately lift the corporate veil.
Mr Salomon appealed; but the appeal was dismissed thought the grounds for dismissal differed from those expressed by the lower court. Lindley L. J. ntimated that Mr Salomon had acted fraudulently when he said “It is manifest that the other members of the company have practically no interest in it, and their names have merely been used by Mr Aron Salomon to enable him to form a company, and to use its name in order to screen himself from liability”. His suggestion that a fraud had been perpetrated by A. Salomon was clarified when he said “There are many small companies which will be quite unaffected by this decision.
But there may possibly be some which, like this, are mere devices to enable a man to carry on trade with limited liability, to incur debts in the name of a registered company, and to sweep off the company’s assets by means of debentures which he has caused to be issued to himself in order to defeat the claims of those who have been incautious enough to trade with the company without perceiving the trap which he has laid for them”. While the case went to the House of Lords it is interesting to note that once again the court sought to lift the veil of incorporation in its attempt to discover a fraud which after 1879 would be considered another legitimate reason for lifting the corporate veil. The House of Lords ruling on Salomon v.
Salomon & Co. Ltd set the standard against which future cases would be judged. Lord Halsbury L. C. made it clear that it was not the courts role to interpret the Companies Act 1862, “The sole guide must be the statute itself”. He later went on to describe Vaughan Williams J. argument as a ‘singular contradiction’, “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 no thing 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”. Lord MacNaghten in addressing Vaughan Williams J. ssertion that the signatories to the memorandum of association were mere nominees of Mr Salomon said “the Act requires that a memorandum of association should be signed by seven persons, who are each to take one share at least. If those conditions are complied with, what can it matter whether the signatories are relations or strangers”.
Addressing the issue of limited liability and Vaughan Williams J. comments he said “If the view of the learned judge were sound, it would follow that no common law partnership could register as a company limited by shares without remaining subject to unlimited liability”. He dismissed the Court of Appeal’s suggestion that Mr Salomon had acted fraudulently and went on to say “It has become the fashion to call companies of this class ‘one man companies’. That is a taking nickname, but it does not help much in the way of argument.
If it is intended to convey the meaning that a company which is under the absolute control of one person is not a company legally incorporated, although the requirements of the Act of 1862 may have been complied with, it is inaccurate and misleading”. It was held that the appeal be allowed, and the counter-claim of the company dismissed with costs (both in this hearing and below). Both Vaughan Williams J and the court of Appeal saw it as the duty of the court to look behind the incorporation of the company.
Each, for different reasons, felt that Mr Salomon was manipulating “the machinery of the Companies Act, 1862 for a purpose for which it was never intended”. However, the House of Lords judgment firmly pulled down the veil of incorporation around the company and its members. It is telling, when Lord MacNaghten referring to Vaughan Williams J. comments on the case stated “Leave out the words contrary to the true intent and meaning of the Companies Act, 1862”. It is clear that Lord MacNaghten and his colleagues held that their role was merely to apply and not to interpret the Companies Act, 1862 and that any such interpretation by the courts was out with their jurisdiction. Nevertheless, later courts have found it necessary to lift the veil of incorporation and over the years there has been a number of exceptions to the principle laid down by the Salomon case that the corporation is a separate legal entity.
Gonzalo Villalta Puig contends that the verdict reached by the House of Lords in the case of Salomon v. Salomon Co. Ltd created a double-edged sword. While the verdict helped to drive capitalism by established the company as a separate legal entity with limited liability and allowed it (the company) to enter into contracts in its own name it also helped promoted the evasion of legal obligations by allowing these benefits to be harnessed by small private enterprises. Goulding agrees with Puig but goes further by suggesting that individuals are encouraged to seek limited liability by becoming a limited company even when such a step is not necessary in their particular circumstances.
These, and other criticisms have their basis in fact. In the years since the Salomon v. Salomon Co. Ltd ruling in 1879 there have been a number of instances where the strict interpretation of the law has been questioned in the courts and the courts have seen fit to look behind the corporate veil. Farrar, in his book ‘Company Law’ outlines several categories under which the courts have sought to pierce the corporate veil, though he is quick to point out the courts have not done this in a systematic way. Rather than defining what is meant by the term ‘incorporation’ and what it does and does not encapsulate the courts have examined this area on a case-by-case basis.
As such, they have maintained the integrity of the Salomon ruling while providing a degree of flexibility but only on a case-by-case basis. It is therefore up to the individual/s who feel they might have a justifiable grievance to take that grievance to the courts and there present a persuasive argument for the corporate veil to be lifted in order that their grievance can be remedied. This in itself can prove very costly and time consuming. Believing one has a justifiable grievance might not be enough for a party to pursue their claim in court as the costs and time constraints might prove prohibitive. While this is not highlighted, by Farrar, it can nevertheless be considered a potential form of abuse.