Salomon v Salomon is one of the most influential cases in English company law

Introduction

Salomon v Salomon, is one of the most influential cases in English company law, which has also been followed in different jurisdictions around the world. It won’t be accurate to say that the case laid down new principles, as they had already been statutorily incorporated in the Joint Stock Companies Act 1844, and the Limited Liability Act 1855. However, Salomon is credited for creating an enduring ratio decidendi, clarifying the law on the area, as well as helping the doctrine of lifting of the corporate veil evolve over time.

This essay discusses and critically analyses the nature of the principle of corporate personality as laid down in the Salomon case, as well as the principle of piercing of corporate veil.

Doctrine of corporate personality and the effects of incorporation

The doctrine of separate personality of the company was a statutory rule at the time Salomon came before the Court of Appeal and then the House of Lords. However, the approaches of the two courts were different. Where the former decided that as the company was controlled by Salomon, it was one-man company and a sham; the latter reversed the decision and held that just because the company was in control of one person, it could not be said that it was a fraud or a sham. This early decision, indicates the judicial dilemma that has always been, and still is a part of corporate personality principles.

In Gramophone & Typewriter Co. Ltd v Stanley, the court held that company does not become an agent even if all the shares in the company are held by one controlling shareholder. These principles are applied in the statutory law and rules as well. The European Community Twelfth Directive on Company Law (89/667) allows incorporation of one-man companies with the principle of limited liability. The Companies (Single Member Private Limited Companies) Regulations (1992), also allows incorporation of one-person private companies with limited liability and in public companies, the same principle is applied under the Companies Act 2006 (CA 2006), s.7. These statutory changes demonstrate the applicability of the Salomon ratio in statutory law.

The principle effect of incorporation is the creation of corporate structure of the company. Consequently, as the company is a legal person, certain effects of incorporation follow. First, the principle of limited liability is applied, as it is also statutorily incorporated in CA 2006. Second, company has perpetual succession, although, the company can be wound up as well under certain circumstances. Third, the company as a legal person is the bearers of rights including proprietary rights. Fourth, the company is the ‘proper plaintiff’ in any actions that are to be taken in the name of the company as laid down in Foss v Harbottle. Only the company can sue for wrongs committed against it. This prevents the minority shareholders from taking derivative action if the majority shareholders ratify the act and prevent the company from taking action. However, to mitigate the effects of the principle for minority shareholders, certain exceptions were developed to allow common law derivative action, which is now statutorily incorporated in CA 2006, part 11 read with section 260 (1). However, the rule of Foss v Harbottle cannot be said to be completely dislodged.

Lifting the corporate veil

(i) The development of the doctrine

The possibility of abuse of corporate structure by the members and directors for the purpose of evading some legal liability or obligation led to the development of doctrine of lifting the corporate veil. Lindley LJ in Salomon applied it because the company was “a mere scheme to enable him [Salomon] to carry on business in the name of the company with limited liability contrary to the true intent and meaning of the Companies Act 1862.”

(ii) The development of the doctrine

CA 2006, s. 399 provides for re-consolidation of accounts of directors and company once every financial year. Officers of the company can be personally liable for failing to make relevant disclosures. During winding up, persons who have indulged in fraudulent trading can be made to contribute to the assets of the company. Similar provisions are made for wrongful trading in the company’s name. Finally, fraudulent trading is a criminal offence punishable by imprisonment or fine or both.

(iii)Application of the doctrine by judiciary: Fraud, sham, enemy character

Courts applied the principle of lifting of corporate veil to prevent fraud or sham in the use of corporate structure. In Gilford Motor Company v Horne Ltd, the court decided that the incorporation of the company in order to evade a contractual liability to a former employer to not solicit their customers, was a sham and the company was an agent of Horne. In Daimler v Continental Tyre & Rubber Co, the court used the doctrine to fix the enemy character of the company during WWI based on the citizenship of its directors, who were Germans (barring one who was British), despite the company being incorporated in England, hence being British. In Jones v Lipman, the company created for the sole purpose of transfer of the house to it, to avoid its sale under contract, was held to be a sham. In Moore Stephens v Stone & Rolls Ltd, the court applied the principle of ex turpi causa non oritur action, by attributing the fraudulent intentions of the sole director to the company itself. In Thorne v. Silverleaf, the court held the company to be a sham because it was established to escape the liability to repay debt.

These cases demonstrate the court’s application of the doctrine, only in case of misuse of corporate structure. Fraud remains an important aspect for application of the doctrine.

(iv) Group structures

The use of group structures has made the application of the doctrine difficult for the courts, although it has been applied in some cases. In an earlier authority, Atkinson J laid down a criteria for deciding whether a company is a wholly owned subsidiary of another. In DHN Food Distributors Ltd v Tower Hamlets London Borough Council, the court applied the doctrine to hold one that for the purpose of compensation for land acquisition, three companies were one entity. In another case, the court held that for single entity, the company must be fully owned. Impropriety or fraud remains an important consideration in such cases.

(v) Tortious liability

In Adams v Cape Industries plc, the court refused to hold the subsidiaries to be a part of a single entity for the purpose of fixing tortious liability, however, the ratio decidendi was not followed in Lubbe v Cape plc. In Chandler v Cape plc, the Court of Appeal held that there was a direct duty in tort owed by a parent company to a person injured by a subsidiary.

Avoidance of legal obligation, fraud, impropriety remain important in cases involving tort by group companies for the purpose of lifting the corporate veil. In Williams v Natural Life Health Foods Ltd, the court refused to apply the doctrine for creating a joint tortfeasor liability for the director and company, because there was no evidence of any personal dealing between the director and the party claiming negligence. However, in MCA Records Inc v Charly Records Ltd (No 5), the court found the director to be the joint tortfeasor with the company.

(vi) Judicial attitude towards the doctrine of lifting of corporate veil: Hesitation to disregard doctrine of corporate personality

The doctrine has been criticized on the ground that it fails to provide an adequate “framework for the evaluation of complex questions.” The confusion with regard to the doctrine became apparent in the recent Supreme Court judgement of Prest v Petrodel Resources Limited, in which the court clarified that the doctrine is of limited application only and will be applied only where some fraud or illegal activity is done by the shareholders and directors by using the name of the company. The case was decided by seven judges and there was lack of consensus amongst the judges on the nature of the doctrine. As per Lord Walker the doctrine was merely a label and not a principle of law; while Lord Sumption and Lord found that the doctrine though a principle was of limited application only; and for Lady Hale there could not be a neat categorization of the doctrine as seen in the case law. Indeed, the doctrine is seen to be sparingly applied, giving way to the doctrine of corporate personality for most of the times.

Conclusion

The ratio decidendi in Salomon’s case is a strong and enduring precedent in the English company law. However, there are decided ill-effects, to mitigate which, the doctrine of piercing of corporate veil has been evolved by the courts. In statutory law as well, these principles have been incorporated, for instance for fraudulent trading under the CA 2006.

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