Published on: 21st November 2024
Authored by: Tanuja Kumari
Faculty of law, Delhi University
Introduction
The landmark case of Salomon v. Salomon & Co. Ltd. is a landmark decision in corporate law that established the principle of the Separate Legal Personality of a corporation. This case set the precedent that a company is a distinct legal entity from its shareholders, even if one person holds most or all the shares. Decided by the House of Lords in 1897, the judgment became a foundational pillar of company law, particularly regarding the liability of shareholders and the legal status of corporations.
Facts of the case
Aron Salomon was a leather merchant and boot manufacturer, who operated as a sole trader. He incorporates a company named Salomon & Co. Ltd to carrying on his business. The scribers to the memorandum were Salomon, his wife, his daughter, and four sons and they remained the only members of the company. Salomon and two of his sons constituted the Board of directors of the company. The business was sold to the company for £38,782. In payment, Salomon took 20,000 shares of £1 each and debentures worth £10,000 and created a charge on the company’s assets. One share was given to each remaining member of his family.
Shortly after the incorporation, the company began to struggle and eventually went into liquidation. The company’s assets were insufficient to cover its debts, and Salomon, as a debenture holder, claimed priority over the unsecured creditors. The liquidator, acting on behalf of the unsecured creditors, argued that Salomon was personally liable for the company’s debts, alleging that the company was merely Salomon’s “agent” or “sham”.
Issues in the case
- Whether Salomon Co. Ltd was a legally incorporated company.
- Whether Mr. Salomon was personally liable to pay the debts of the company.
Defendant’s (Liquidator) Contention
The unsecured creditors contended that although the company was incorporated under the Act, it lacked an independent existence and was essentially Salomon operating under a different name. As the managing director, with his sons as subordinate directors, and holding the majority of shares, Salomon was the absolute master of the company. The business was entirely his, operated exclusively by him, rendering the company a sham and a fraud, effectively subverting the intent and purpose of the Companies Act.[1]
The liquidator sought to treat the company as a mere face and insisted that the corporate veil be lifted, making Mr. Salomon personally liable for the company’s debt.
Appellant’s (Aron Salomon’s) Contention:[2]
Salomon argued that the company was a separate legal entity under the Companies Act of 1862, and he could not be held personally liable for the company’s debts.
He maintained that he was entitled to his rights as a secured creditor, as the debentures he held were legitimate.
He had followed all legal procedures, and the fact that he owned most of the company’s shares did not alter the company’s legal status as an independent entity.
Observation
Trial court decision:
VAUGHAN WILLIAMS, J., gave the company decree of Indemnity, on the ground that the appellant was in truth the company, the other members being either his trustees or mere “dummies”, and, consequently, that the appellant carried on what was truly his own business under cover of the name of company, which was nothing more than an alias for Salomon.[3]
Court of Appeal decision:
LINDLEY, L. J., on the other side, states that although there were seven people in the corporation, it is obvious that six of them were only there to give the seventh person the capacity to operate with little liability. The entire setup is designed to do the exact thing that the legislature aimed to avoid doing. Furthermore, he stated, “Mr. Salomon’s scheme is a device to defraud creditors.”[4]
Observation of House of Lords
Their Lordships of the House of Lords observed: the company was established in accordance with the act; thus, the allegation of fraud is invalid. Furthermore, the company exists as an independent legal entity. Once the memorandum is properly signed and registered, even if only seven shares are taken, the subscribers become a corporate entity immediately capable of performing all functions of an incorporated company[5].
It is challenging to comprehend how a corporate entity, established by law, can lose its individuality by allocating the majority of its capital to a single individual. Legally, the company is a separate entity from the subscribers to the memorandum; and although the business may operate identically post-incorporation, with the same individuals managing and the same hands receiving profits, the company is not, in legal terms, their agent or trustee.
The House of Lords rejected the argument that the company was a sham or an agent of Salomon. There was no evidence of fraud or improper conduct in the incorporation process. The court emphasized that the motives behind forming a company were irrelevant, as long as the statutory requirements were fulfilled. In this case, Salomon had complied with all the legal formalities, and the company was not a façade for fraud.
Judgement
The House of Lords unanimously reversed the decision of court of appeal, dismissing the arguments of fraud and agency. The court held that there is nothing in the Act requiring that the subscribers to the memorandum should be independent or unconnected, or that there should be anything like a balance of power in the constitution of company. If one person owns the majority of the company’s capital, the company does not lose its identity. The company at law altogether different person from its subscribers[6].
The House of Lords held that, since the company was duly registered, it was a legal entity having its own rights and obligations, distinct from those of its members.
The House of Lords confirmed that Salomon’s claim as a secured creditor was valid. As a debenture holder, he had a right to be paid before the unsecured creditors, and the fact that he was also the principal shareholder did not affect the legitimacy of his claim.
Analysis of Salomon v. Salomon & Co. Ltd. In the Indian Context
The landmark case of Salomon v. Salomon & Co. Ltd. (1897) established the principle of separate legal personality, which holds that a company, upon incorporation, becomes a distinct legal entity, separate from its shareholders. This principle, which is central to corporate law, is also enshrined in Indian law through the Companies Act, 2013.
Indian law adopts the same principles laid down in Salomon v. Salomon. According to Section 9 of the Companies Act, 2013, upon registration, a company acquires a separate legal personality, and its liability becomes limited. Section 34 and Section 35 reinforce that shareholders are only liable for the unpaid capital on their shares, and not for the debts of the company. Indian courts have followed these doctrines closely, though they have also developed certain exceptions through case law.
This legislative framework reflects how the fundamental principles of Salomon are deeply embedded in the Indian legal system.
Relevant Examples in the Indian Context
- Tata Engineering and Locomotive Co. Ltd. V. State of Bihar (1964)[7]: The Supreme Court of India upheld the principle of separate legal personality, ruling that the assets of a company belong to the company itself, not its shareholders. This case reinforced that the company is a distinct legal entity, independent of its shareholders, in line with the doctrine from Salomon.
- Life Insurance Corporation of India v. Escorts Ltd. (1986)[8]: The Supreme Court ruled that a company, once incorporated, becomes a legal person with rights, obligations, and liabilities distinct from its shareholders. This judgment reiterated the principle of separate legal entity and limited liability, echoing the decision in Salomon.
Conclusion
The Salomon v. Salomon case is a landmark decision that fundamentally shaped the principles of corporate law, particularly the doctrine of separate legal personality and limited liability. The House of Lords’ ruling affirmed that, once incorporated, a company becomes a distinct legal entity, separate from its shareholders. This concept shields shareholders from personal liability for the company’s debts, limiting their liability to the value of their shares.
The case established that even if a company is largely owned and controlled by a single individual, as in Salomon’s case, the company remains an independent legal entity. This ruling has had lasting implications for business structures worldwide, encouraging entrepreneurship by allowing individuals to separate their personal assets from business risks. The Salomon case set the foundation for the development of modern corporate law, and the principles it established continue to be central to business practices globally.
References:
[1] Harsh ram, “Case analysis: Salomon v/s Salomon & Co Ltd [1896]” (legal service India) < https://www.legalserviceindia.com/legal/legal/legal/article-13655-case-analysis-salomon-v-s-salomon-co-ltd-1896-ukhl1.html >, Ayush Upadhyay, “SALOMON V. SALOMON & CO. LIMITED”, (Law Foyer, 7 July 2023) < https://lawfoyer.in/salomon-v-salomon-co-limited/ > accessed 17th September 2024
[2] Ibid
[3] Salomon v A Salomon & Co Ltd, (Wikipedia, 14 August 2023) https://en.wikipedia.org/wiki/Salomon_v_A_Salomon_%26_Co_Ltd accesses 15th September 2024
[4] Ibid
[5] “Salomon vs. Salomon – Case Summary”, (Law Teacher, 2 January 2023), < https://www.lawteacher.net/cases/salomon-v-salomon.php > accessed 16th September 2024
Mehul Jain, “Case Summary: Salomon vs. Salomon & Co. Ltd.”, (Law lex, 14 June 2020),< https://lawlex.org/lex-bulletin/case-summary-salomon-v-salomon-co-ltd/23368 > accessed 16th September 2024, Salomon v A Salomon & Co Ltd, (Wikipedia, 14 August 2023) https://en.wikipedia.org/wiki/Salomon_v_A_Salomon_%26_Co_Ltd accesses 15th September 2024
[6] Ibid
[7] (1964) 6 SCR 885
[8] Life Insurance Corporation of India v. Escorts Ltd., MANU / SC / 0015 / 1985,
