The Salomon and Co. Case

The Salomon & Co.

[1] case brought about the most significant decision ever laid down in Company Law.The House of Lords decision is the leading authority on the principle that the company [2], which is incorporated under the Companies Acts 1963 is a separate legal entity, separate from its members and capable of having a corporate personality of its own, as Lord MacNaghten stated in Salomon “a different person altogether”[3], from that of the members, almost depicting a fictional character capable of acting on its own behalf, entering into its own contracts, owning property, having the ability to sue and be sued but most importantly, its members by way of limited liability are not liable for the debts of the company to their creditors.Aaron Salomon, ran a profitable business as sole trader as a leather and boot manufacturer in Whitechapel, London and on advise decided to register a company and sell to it, his business for the sum of ? 39,000 sterling. He received payment by way of 20,000 ? 1 shares, which he divided among his family, issuing one each to his five children and another to his wife. He kept the remaining shares.

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The outstanding sum was issued to Salomon by way of a debenture and the company was in debt to him.This placed Salomon in the position of principal shareholder and creditor of Salomon & Co. Ltd. Due to a downturn in the business at the time the company experienced some difficulties and Salomon took out a further mortgage to help keep the company afloat. But when this loan fell into arrears an action was brought by the liquidator Mr. Broderip against the appellant, Aran Salomon, which was tried before Mr.

Justice Vaughan Williams[4]. The liquidator tried to maintain that the original debenture issued to Salomon was invalid as Salomon and Salomon & Co. ere in fact the same person and he was operating as he had done so in the past, that the company was merely an agent of Salomon and therefore he was personally liable for the debts of the company. Vaughan Williams said that the company “…had been some servant of Mr. Salomon’s to whom he had purported to sell his business,”[5] In fact the Court of Appeal held that Salomon had perverted the incorporation of the company in so far as it was a “wholly unwarranted perversion of the companies’ legislation. “[6] The company was a sham.

Salomon appealed to the House of Lords and they unanimously rejected the decision of the Court of Appeal and held that the company had been properly formed and was a legal person in its own right separate from its members and legally had to be treated as such. Creditors had to respect the legal parameters of incorporation, as the company was different to the subscribers or members of the memorandum even though at first glance it may seem that the company is as one with them, the company is in fact separate and not liable for any debts incurred but for those that exist under the Companies Act.Lord MacNaghten stated that “The company is at law a different person altogether from the subscribers to the Memorandum, and although 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 receive the profits, the company is not at law the agent of the subscribers or a trustee for them. Nor the subscribers as members liable, in any shape or form, except to the extent and in the manner provided by the act. And thus was borne the Salomon Principles, forever more to be the bedrock of Company Law, or was it? While the Court of Appeal’s decision was reversed the House of Lords held that the company in its privileged position of having separate legal personality, it could only do so if ‘there was no fraud and no agency and if the company was a real one and not a fiction or a myth’. [7] And so from this point on right up to the 1970’s, the segregation of the company from its shareholders became firmly embedded as a fundamental principle of Company Law and was rarely overruled.

Otto Kahn-Freund called the decision ‘calamitous’ in his article, “Some Reflections on Company Law Reform;”[8] “the courts had failed to see through the rigidities of the ‘folklore’ of corporate entity in favour of the legitimate interests of the company’s creditors”. [9] But legislature and the courts sought to restrict the principle of Salomon by piercing or lifting the corporate veil in difficult situations especially in regards to wholly owned subsidiaries. Examples can be found where the courts ave lifted the corporate veil in certain categories, but equally there are situations where the courts upheld the separateness of the companies involved. The courts will generally move to disregard the separate legal personality of the company where it is found that (a) the company may be an agent of another, (b) where the company is being used for fraud or tax avoidance or an avoidance of a legal obligation (c) where a group of companies exist and justice requires them to be regarded as a single economic entity or (d) compliance with a court order and exceptions to the rule can be seen almost from the time of Salomon (1896).In Re Darby[10] the company was set up to defraud money from an existing company. The court held that the company was a device whereby the directors pocketed the money defrauded from the creditors of the first company and they were to repay all monies owed.

In Daimler Co. Ltd. v Continental Tyre and Rubber Co. (Great Britain) Ltd. [11] the courts, on lifting the corporate veil found that the English company was in fact an enemy alien during world War One because of its German shareholders.

In Gilford Motor Company Ltd v Horne[12]a restrictive covenant on a former employee bound him to an agreement that he would not solicit customers from his former employer on leaving the company. But he set up a company with his family thinking that he could avoid the agreement but again the court found that the company was a sham, a front for the company to avoid his contractual obligation and the court issued an injunction against him.In Jones v Lipman (1962), the defendant Lipman, entered into a contract to sell land to Jones, but Lipman changed his mind and in order to avoid the contract he formed a company and transferred the land to the company. His belief was that if he did not own the land personally he could not therefore convey the land to Jones and the contract would be void but the Judge, Russell J. rejected this notion of the company being a separate entity and aintained that the company was ” the creature of the defendant, a device and a sham, a mask which he holds before his face in attempt to avoid recognition by the eye of equity”.

[13] He granted and order to Jones for specific performance of the original contract. Roundabout Ltd v Beirne[14] was the first case to uphold Salomon in Ireland. The court held this ‘legal subterfuge’ did not break any legal rules so therefore there was no need to disregard the separate legal personality to examine the economic realities of the company.The owners of a public house decided to set up a new company when some of their employees held a picket on the premises. The owners did not want a unionised workforce and set up the new company appointing the non- union barmen as directors. The owners then went to the courts to restrain the dismissed employees from picketing their premises claiming that they could not legally picket the pup unless it was ‘in furtherance of a trade dispute’ and the new company was not their employer.

The injunction was granted to the owners and the ex-employees were ordered to cease their pickets. 15] It was stated in the case of MacLaine Watson & Company Ltd. v Department of Trade and Industry[16] that Salomon ‘is as much the law today as it was in 1896′. The International Tin Council was set up by a number of countries in order to regulate the price of tin but when the company ran out of money, the creditors brought a case against the member states that were involved in its formation. The court held that the member states were not liable for the debts as they remained separate from the company and therefore only the company shall remain liable.

But in the case of Smith, Stone and Knight v Birmingham Corporation[17], “in apparent conflict with Salomon’s case to infer the existence of a relationship of agency or trust between companies in the same group”,[18] the plaintiff Smith Stone and Knight, sought to prove that the subsidiary was in fact an agent of the parent company, and when the defendant compulsorily acquired the land in which the subsidiary was based, the parent company looked for compensation for the disruption of the business. Six Factors were taken into consideration when deciding whether the subsidiary was acting as an agent of the parent company. 1. Were profits of the subsidiary treated as profits of the parent company? 2. Were persons conducting the business of the subsidiary appointed by the parent company? 3.

Was the parent the “head and brain” of the trading venture? 4. Did the parent govern the venture deciding what was to be done and how it should use its capital? 5. Were the profits made by the skill and direction of the parent company? 6.Was the parent in ‘effectual and constant control’ of the subsidiary? Keane stated that he remained doubtful whether, ” ‘these criteria are of general application’ and this case should be limited to its facts”. [19] Keane goes on to say that if these principles were applied in every case “a significant number of subsidiaries would have to be treated as the agents of their holding companies.

” He stated that the courts seem to be more willing “to draw the inference of agency where the controlling shareholder is another company………where there is no other shareholder. “[20]In the 1970’s and 1980’s the courts sought to move away from the precedence of Salomon and disregard the separate legal personality of companies where the company was part of a larger group of companies if the justice of the case required it and the first indication of this ‘single economic entity’ was in the case of DHN food Distributors Ltd. v Tower Hamlet London Borough Council,[21] DHN was a holding company and operated a business on land owned by the subsidiary company. London Borough Council sought to (CPO) compulsorily purchase the land in exchange for a small fee.But Lord Denning held that they were entitled to compensation for the disturbance.

He said that the group of companies were acting as a single economic entity and should therefore be treated as one. [22] Five years later Carroll J adopted Lord Denning’s view in Power Supermarkets Ltd. v Crumlin Investments Ltd. [23] Crumlin Investments Ltd. agreed to lease a unit of the Crumlin shopping centre to Power Supermarkets who ran the Quinnsworth chain. They agreed not to sell or lease a unit to any other grocery or supermarket while Power Supermarkets held a lease in the building.

But the shopping centre was not a success and Crumlin Investments decided to sell the whole centre to Cornelscourt Shopping Centre Ltd. being one of the Dunnes Stores subsidiaries. Dunnes felt it appropriate to open up a store at the centre under a new company, Dunnes Stores (Crumlin) Ltd. Power Supermarkets Sought an injunction to restrain them from operating. Costello J held that Dunnes Stores were bound by the lease even though they were not a party to it and the court could treat the two related companies as a single legal entity if it conformed to the economic and commercial realities of the situation. 24] The ‘single economic entity’ principle in Power Supermarkets was approved yet again along with Lord Denning’s in DHN in the Supreme Court in Re Bray Travel and Bray Travel Holdings Ltd. [25] ‘and may be regarded as the law today in Ireland. [26] But Keane is of the opinion that the law is too widely stated. “The ‘justice of the case’ is a somewhat elusive concept and it is extremely difficult to predict with anything approaching certainty how it might or should be applied in specific cases. [27] Carroll J held in the High Court that the corporate veil did not need to be lifted where the two companies sought to be regarded as a single legal entity.

No relationship was found to exist between the subsidiaries and therefore refused to disregard the separate legal personality of the group. [28] Costello J again refused to disregard the separate legal personality in the case of Rex Pet Foods Ltd. v Lamb Bros (Dublin) Ltd. [29] While in the UK Denning encouraged the concept of lifting the corporate veil, there was a growing disquiet to the idea. 30] Adams v Cape Industries PLC [1990] BCLC 479 probably typifies the application of Salomon in the English courts.

Cape Industries was a large English based multinational company with subsidiaries throughout the world. When several hundred employees developed Mesothelioma and Asbestosis from mining asbestos in South Africa, they decided to take a case in the American courts for damages of over $20 million. The company was put into liquidation and a new company CPC took over the operations. Employees of the new company CPC in a subsequent case took an action against the company for $15. 4 million in the American courts but as there were no remaining assets left in the USA, they sought to enforce the judgement in the English court of appeal.

But Slade LJ held that the awards could not be enforced against Cape Industries even though they had deliberately formed the subsidiary companies to avoid liability. [31] Back In Ireland, the courts pierced the corporate veil in Fyffes PLc v DCC PLc & Ors[32] in order to examine the issue of insider dealing with one of its subsidiaries. DCC and S&L Ltd were subsidiaries of Fyffes of which Mr.Flavin was a director of two of the companies, S&L and Fyffes and chief Executive of the third, DCC. Mr Flavin sold off the shares he had acquired in DCC and S&L and sold onto a subsidiary company of DCC, called Lotus Green Ltd.

Lotus Green then went on the sell shares in Fyffes when they were at their highest value, making a staggering 85 million euro in profit. Fyffes sought to bring an action against him for insider dealing having acquired what they called ‘price sensitive information’ being a director of the company.Laffoy held that the companies should be treated as a single economic entity where to do otherwise would fustrate the law[33] on insider dealing and would be unfair to the outsider who required its protection. In 2007 the Supreme court overruled Laffoy’s earlier decision on dealing was unlawful under section 108 and 109[34] of the ‘1990 Act’ and held that the information was price sensitive. It seems as though there are no conclusive decisions apart from what has been laid down in statute, as to which way the courts are approaching the anomaly of separate legal personality.In fact it seems that the courts are becoming less reluctant to look into the ‘economic realities of corporate facades’.

[35] In cases where the single economic entity of the company is being questioned, the Irish courts have moved to re-establish the importance of Salomon and to firmly reject any notion that just because there may be a relationship existing between a subsidiary and its parent that they would automatically disregard the separate legal personality of those companies. The recent trend of the courts reveals a significant reluctance to introduce any general rule of disregard of the separate legal personality of companies in groups beyond those enunciated in Salomon’s case. ‘[36] The legislature in the form of the Companies Act 1963 and more recently the Companies Act of 1990 hereinafter referred to as the ‘1963 Act’ and the ‘1990 Act’ has moved to ignore the principle of separate legal personality in order to prevent companies from abusing their privilege of limited liability.The relevant statutory provisions are as follows: Under the Companies Act 1963 Section 36 will hold the shareholder liable for the debts of the company if it knows the company was run without the required number of persons for more than six months. [37] Section 114 – The company and officers will become liable for all the debts of the company of the company does not use the name of the company in the proper fashion.

[38] Section 150 – At the end of its financial year subsidiaries must lay their group accounts before the annual general meeting.Section 256(8) If a director make a declaration that the company is solvent on a voluntary winding up of the company and then is subsequently found to be untrue, the director shall be liable for the debts of the company. Section 297 will declare a person personally responsible for the debts of the company if it appears that a company has been carried on with intent to defraud creditors or was set up for any fraudulent purpose.Section 297 as amended by Section 137 of ‘1990 Act’ If any person carrying on the company with intent to defraud creditors or sets up the company for any fraudulent purpose, that person shall be guilty of an offence. [39] Section 297(A) as amended by Section 138 of ‘1990 Act’ If any person carries on the company in a reckless manner; or with intent to defraud creditors of the company, or sets up for any fraudulent purpose shall be personally responsible for all or part of the debts of the company. [40] Under the Companies Act 1990Section 9 – An inspector appointed to investigate the affairs of a company may also investigate the affairs of any related company with that group.

Section 39 – If a company is being wound up and is unable to pay its debts due to directors taking loans the directors shall be personally liable for the debts of the company. Section 140 – Any company related to the company being wound up shall pay for the debts in that insolvent company on winding up. [41] Section 150 – A director shall not take part in any company for five years unless it meets capital requirements laid down in the section ? 00,000 Irish Punts for a public company and ? 20,000 for a private limited company. [42] Section 160(1) automatically disqualifies a director for five years if he commits an offence under section 160(2). [43] Section 163(3) If a director has been restricted or is subject to a disqualification order, and acts for a company which is wound up shall be liable for the debts of that company. Section 202 A director of a company shall be liable for the debts of the company where there was a failure to keep proper books of accounts and this contributed to its winding up.

44] In the absence of ‘hard and fast rules’, Keane suggests that from the plethora of ‘conflicting decisions’ that exist today in this area that these principles ‘may be extracted with some hesitation’ as the rules by which the courts base their decisions. [45] It seems that Salomon still rules and only the courts will decide when the veil of incorporation shall be ceremoniously lifted! ———————– [1] Salomon v Salomon & Co Ltd [1897] A. C. 22 [2] Under the Companies Act 1963 No. 33/1963 the ‘Company’ is defined as a company formed and registered under the act or an existing company that may have existed prior to the act.

3] ” The company is at law a different person altogether from the subscribers to the Memorandum…. ” [4] Broderip v Salomon[1895] 2 Ch 323. [5] Reported sub nom Broderip v Salomon [1895] 2 Ch 323 cited at Thomas Courtney The Law of Private Companies (2nd ed. , 2008) at 164. [6] Reported sub nom Broderip v Salomon [1895] 2 Ch 323 cited at Ronan Keane Company Law (Dublin, 4th ed. , 2007) at 121.

[7] Lord Halsbury [1897] AC 22 and 23 Grainne Callanan cited at An Introduction to Irish Company Law (Dublin, 3rd ed. , 2007) at 63. 8] Otto Kahn Freund “Some Reflections on Company Law Reform” (1944), 7 M. L. R. 54 [9] Thomas Courtney The Law of Private Companies (2nd ed.

, 2008) at 165. [10] [1911] 1 KB 95 [11] (1916) AC 307 [12] (1933) Ch. 35 [13] [1962] 1 All ER 442 at 445 cited at Ronan Keane Company Law (Dublin, 4th ed. , 2007) at 130. [14] [1959] IR 423 [15] Dixon J said: “The new company is in law a distinct entity, as is the old company. Each company is what is known as a legal person.

I have to regard the two companies as distinct in the same way as I would regard two distinct individuals.I must therefore, proceed on the basis that a new and different person is now in occupation of the premises and carrying on business there. ” Thomas Courtney The Law of Private Companies (2nd ed. , 2008) at 193. [16] [1988] 3 WLR 1033 [17] Smith, Stone and Knight v Birmingham Corporation [1939] All E.

R. 116 [18] Ronan Keane Company Law (Dublin, 4th ed. , 2007) at 133. [19] Keane Company Law, (3rd Ed. ) P. 130.

cited at Marguerite Gallagher “Separate Legal Personality – Lifting the Corporate Veil” (2005) 23 ILT 167 [20] Ronan Keane Company Law (Dublin, 4th ed. 2007) at 134. [21] DHN food Distributors Ltd. v Tower Hamlet London Borough Council [1976] 3 ER 462 [22] “We all know that in many respects a group of companies are treated together for the purpose of general accounts, balance sheet, and profit and loss account. They are treated as one concern. Professor Gower in Modern Company Law, 3rd ed.

(1969), p. 216 says: “there is evidence of a general tendency to ignore the separate legal entities of various companies within a group, and to look instead at the economic entity of the whole group. This is especially the case when a parent company owns all the shares of the subsidiaries – so much so that it can control every movement of the subsidiaries. These subsidiaries are bound hand and foot to the parent company and must do just what the parent company says. This group is virtually the same as a partnership in which all the three companies are partners. They should not be treated separately so as to be defeated on a technical point.

They should not be deprived of the compensation which should justly be payable for disturbance.The three companies should, for present purposes, be treated as one, and the parent company D. H. N. should be treated as that one. So D.

H. N. are entitled to claim compensation accordingly. ” Thomas Courtney The Law of Private Companies (2nd ed. , 2008) at 230. [23] Power Supermarkets Ltd.

v Crumlin Investments Ltd. (unreported HC 22 June 1981) [24] “It seems to me to be well established that a court may, if the justice of the case so requires, treat two or more related companies as a single entity so that the business notionally carried on by one will be regarded as the business of the group or another member of the roup if this conforms to the economic and commercial realities of the situation” Ronan Keane Company Law (Dublin, 4th ed. , 2007) at 139. [25] Re Bray Travel and Bray Travel Holdings Ltd. (13 July 1981, Unreported), Supreme Court.

[26] Thomas Courtney The Law of Private Companies (2nd ed. , 2008) at 231. [27] Ronan Keane Company Law(Dublin, 4th ed. , 2007) at 140. [28] Carroll J stated “the corporate veil is not a device to be raised and lowered at the option of the parent or group.

The arm, which lifts the corporate veil must always be that of justice.If justice requires (as it did in the DHN case) the courts will not be slow to treat a group of subsidiary companies and their parent companies as one. But can it be said that justice requires it in this case? ” Ronan Keane Company Law (Dublin, 4th ed. , 2007) at 141. [29] Rex Pet Foods Ltd. v Lamb Bros (Dublin) Ltd.

(5th December, 1985, unreported), HC. [30] Woolfson v Stratclyde Regional Council [1978] SC 90 [31] Slade LJ said “…the court is not free to disregard the principles of Salomon merely because it considers that justice so requires.Our law for better or worse, recognises the creation of subsidiary companies which though in one sense the creatures of their parent companies will nevertheless under general law fall to be treated as separate legal entities with all the rights and liabilities which would normally attach to such legal entities. ” Ronan Keane Company Law (Dublin, 4th ed. , 2007) at 141.

[32] [2005] IEHC (21 December 2005) [33] Part V. Companies Act 1990 [34] Section 108 of the 1990 Act. Unlawful dealings in securities by insiders. Section 109 of the 1990 Act. Civil liability for unlawful dealing.

35] Forde and Kennedy Company Law (4th edition, Dublin, Thomson Round Hall, 2007) 45. [36] Allied Irish Coal Supplies v Powell Duffryn International Fuels ltd. [1998] 2 IR 519 as cited at Thomas Courtney The Law of Private Companies (2nd ed. , 2008) at 229. [37] Applies now to unlimited private companies since the enactment of the European Communities (single member Private Limited Companies) Regulations 1994. [38] Durham Fancy Foods Limited v Michael Jackson (Fancy Foods) Ltd.

[39] Re Aluminium Fabricators Ltd. (Unrep HC May 13 1983) [40] Re Hefferon Kearns Ltd. No2) [1993] 3 IR 191 [41] Power Supermarkets Ltd. v Crumlin Investments Ltd. (Unrep HC 22 June 1981) [42] Re Costello Doors Ltd.

(Unrep HC July 21 1995) [43] Re CB Readymix Ltd. Cahill & Grimes, (Unrep HC March 1, 2002) [44] Re Ashclad Ltd. (Unrep. HC April 5, 2000) [45] (1) The rule in Salomon’s case is still the law. The company and its shareholders are separate legal entities and the courts normally cannot infer from the degree of control exercised by the shareholder a relationship of principal and agent or beneficiary and trustee between the shareholders and the company.2) The courts, however, will not permit the statutory privilege of incorporation to be used for a fraudulent, illegal or improper purpose.

Where it is so misused, the court may treat the company thus incorporated as identical with its promoters. (3) In certain cases, where no actual misuse of the privilege of incorporation is involved, the courts may nonetheless infer the existence of an agency or a trust if to do otherwise would lead to injustice or facilitate the avoidance of tax liability. 4) In the case of a group of companies, the court may sometimes treat the group as one entity, particularly where to do otherwise would have unjust consequences for outsiders dealing with companies in the group. (5) The rule in Salomon’s case does not prevent the court from looking at the individual members of the company in order to determine its character and status and where it legally resides. Ronan Keane Company Law (Dublin, 4th ed. , 2007) at 145.