Citation- (1897) A.C. 22, [1896] UKHL 1
(Even where a single shareholder virtually holds the entire share capital of a company, the company is to be differentiated from such a shareholder.)
Issues Involved
- Whether the Salomon & Co. Ltd. was a company at all?
- Whether in truth the artificial creation of the legislation, i.e., the company, had been validly created in the instant case?
- Whether Salomon was liable for the debts of the company?
Facts in brief
Aron Salomon had for many years carried on a prosperous business as a leather merchant. In 1892, he decided to convert it into a limited company and for that purpose Salomon & Co. Ltd. was formed with Salomon, his wife, his daughter and his four sons as members, and Salomon as Managing Director.
The company purchased the business of Salomon for £ 39,000. The price was satisfied by £ 10,000 in debentures, conferring a charge over all the company’s assets, £ 20,000 in fully paid up £ 1 shares, and the balance in cash. Seven shares were subscribed in cash by the members and the result was that Salomon held 20,001 shares out of 20,007 shares issued, and each of the remaining six shares was held by a member of his family. The company almost immediately ran into difficulties and only a year later then holder of debentures (Salomon had transferred his shares to another person) appointed a Receiver and the company went into liquidation. On liquidation the state of affairs of the company was broadly like this:
Realisable value of Assets: £ 6,000; Liabilities: Debentures-£ 10,000; Unsecured Debts- £ 7,000.
Thus, after paying off the debenture holders nothing would be left for the unsecured creditors. An action was brought by the liquidator against Salomon holding him liable to indemnify the company against the company’s trading debts.
Argument
The Liquidator contended that though Salomon & Co. Ltd. Was incorporated under the Act, the company never had an independent existence. It was only a one man show since all the shares except six were held by Salomon himself. The vast preponderance of shares made Salomon absolute master. The business was solely conducted for and by him and the company was mere sham and fraud.
Judgement
The House of Lords held that in order to determine the question it is necessary to look at the statute itself without adding to or taking from the requirements of the statute. The sole guide must be the statute itself. In the present case, the Act provided that any seven or more persons, associated for a lawful purpose may, by subscribing their names to a memorandum of association and otherwise complying with the provisions of the Act in respect of registration form a company with or without limited liability.
The Act further provided that “no subscriber shall take less than one share.” That there were seven actual living persons who held shares in the company was never doubted. Since the company fulfilled all the requirements of the Act, the court held that the company had been validly formed and was a real company.
Rejecting the contention of the Liquidator that all the shares were bought by Salomon and his family members and that the company was nothing but one man show, House of Lords held that the provisions of the Act did not require that the persons subscribing shall not be related to each other or that holding of a single share shall not afford a sufficient qualification for membership. Whether the capital of the company is owned by seven persons in equal share, with the right to equal share in profits, or whether it is almost owned by one person who takes practically the whole profits, it does not concern a creditor of the company. The company does not lose its identity if the bulk of its capital is held by one person. The company at law is altogether different person from its subscribers. The House of Lords further stated that the Act said nothing about the subscribers being independent or that they should take a substantial interest in the undertaking, or that they should have a mind and will of their own.
To quote Lord Macnaghten: “The company is at law a different person altogether from the subscribers..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 receive the profits the company is not in law agent of the subscribers or trustee for them. Nor are the subscribers, as members, liable in any shape or form, except to the extent and in the manner provided in the Act.
Reform
Shortly after the decision was handed down the Preferential Payments in Bankruptcy Amendment Act 1897 was passed into law as a response. The effect of that statute was to provide that certain classes of preferred creditors would take priority over the claims of a secured creditor under a floating charge. However, the effectiveness of that Act was limited by the fact that a floating charge crystallises into a fixed charge prior to enforcement, and so it was not until the Insolvency Act 1986 modified the provision to state that a floating charge include any charge which was created as a floating charge (i.e. irrespective of subsequent crystallisation) that priority of the preferred creditors was promoted ahead of the floating charge holders.[1]
Conclusion
The concept of lifting of the corporate veil was later introduced after this case where no person could hide behind the company’s entity to commit fraud and avoid any sort of liability. A certain amount of proximity should be there to apply this concept of lifting the veil. In this case it was decided that no illegal or sham act has been done by Mr. Aron and that he was legally the creditor of the company and has a right to be paid at the winding up of the company before the unsecured creditors as his debt was secured by a charge against the assets of the company.
Bibliography
https://www.bailii.org/uk/cases/UKHL/1896/1.html