Salomon V Salomon & co Ltd: This is a landmark case under company law decided in 1897 in the UK jurisdiction. The case established that a Limited Liability Company wears an independent legal identity from its shareholders. Therefore, shareholders cannot be held responsible for the debt and liabilities of the company.
Issues determined in Salomon V Salomon
a. Whether an individual shareholder of a company can be held liable for the company’s debt and liability.
Facts of the Case of Salomon V Salomon
Aron Salomon operates a sole proprietorship type of business under which he produces leather boots and shoes. Later on, he converted the business type to a Limited Liability Company. This he did because his sons wanted to partner with him in the business. Salomon after turning his sole proprietorship business to a Limited Liability Company sold it to the company, A Salomon & Co Ltd at a price higher than the business value. Afterwards, Salomon’s two sons were made directors of the company while themselves, their other siblings and the wife of Salomon became shareholders in the same company, making it 7 shareholders.
Salomon was the major shareholder of the company. So, he secured his debentures. Not so long after the company was incorporated, boot sales started to decline, and in fact, the business failed. Edmuns Broderip who also secured his debentures saved sued the company and recovered his 5,000 pounds. Salomon who was the major shareholder was left with the remaining company’s asset and the issue was that if he successfully claims his interest, there would be nothing left for other shareholders of the company to claim. The shareholders were of the position that Salomon be held liable for the debts owed to them by the company, since he was the owner and the major shareholder. It was on this basis that Salomon instituted an action for the determination of the question of liability. The company liquidators counter-claimed.
Their contention was that Salomon had formed the company in expectation of its failure in order to benefit from the unsecured debentures, therefore, that he had acted fraudulently starting from when he sold his sole proprietorship business to A Salomon & Co Ltd at an exorbitant price. Their position was the Salomon’s debentures were to be cancelled and that he should relinquish his interest that was already paid to him in order to settle the claims of other shareholders of the company.
The question before the court was whether Mr. Salomon as a person was to be held liable for the debt of his company, A Salomon & Co Ltd.
Judgment of the court in Salomon V Salomon
At the High Court, it was held that Salomon was to be liable for the company’s debt. The High Court in its decision likened the position of Mr. Salomon to his company to that of an agent (that A Salomon & Co Ltd was an agent of the Principal, Salomon). When therefore the company incurs debt, an agent that it was, the principal has the legal burden to bear the liability and indemnify the shareholders. The company was in fact regarded as a representative of Mr. Salomon. It was on this basis that the High Court ruled that Mr. Salomon was to be responsible for the indemnity of the company’s debt.
On appeal to the Court of Appeal, the High Court’s decision was upheld. The court regarded the position of Mr. Salomon to the A Salomon and Co Ltd as that of a trustee and therefore was to be held liable for the debt of the company. The court added that there was an abuse of the Limited Liability Company privileges by Mr. Salomon. This reasoning was based on the fact that Mr. Salomon had very significant portion of interest in the company which in fact constitutes most of the assets of the company, whereas other shareholders of the company have insignificant interest.
Recall that if Mr. Salomon claims his interest successfully, there would be nothing left for the other shareholders of the company to claim. Court of Appeal observed that Mr. Salomon had merely used the shareholders’ names and signatures in order to fulfill the requirement of forming a Limited Liability Company.
The court further observed that nothing strips off A Salomon Co Ltd its status as a corporation notwithstanding that it was perceived to have been formed for a purpose which was illegitimate. In an incorporated company of 7 members, the court observed that while 6 members owns the share of one pounds only, one person owns the rest. This was not the sole ground upon which the Court of Appeal relied on to have arrived at its decision; it was because the court perceived that the purpose of formulating the company and the circumstances surrounding the events pointed towards a fraudulent intend to use the privilege of Limited Liability Company and incur debts, and then claim his secured debentures to the expense of other shareholders who were not cautions enough to perceive the anticipatory fraud.
The Court of Appeal also based its reasoning on the fact that Mr. Salomon was at the forefront of A Salomon & Co Ltd. the company was so attributable to him that if question arises as to whose business it was, the answer would be Aron Salomon’s. It was through Mr. Salomon that the company could be reached. Moreso, he takes beneficial interest in the company. These were the reasoning of the Court of Appeal for arriving at the decision that Mr. Salomon was to be held responsible for the indemnity of the company’s debt.
On further appeal to the House of Lords, the decisions of the courts below were overruled. The court rejected that argument that the position of Mr. Salomon to A Salomon & Co Ltd was that of an agency relationship, on further interpretation, the House of Lords stated that the law must be applied the way it is and that nothing should be added or removed. The law never provided or the degree of interest on can hold in Limited Liability Company
The court therefore held that since the Limited Liability Company was duly constituted, it wears a legal entity capable of independent existence. The company does not belong to Mr. Salomon; the company is rather an independent one, wearing a different entity from Mr. Salomon. The House of Lords also held that it found nothing showing that Mr. Salomon had acted in a fraudulent manner. Mr. Salomon was therefore entitled to his share first as the major shareholder as required by the law.
The House of Lords added that the other shareholders were to be sympathized with. They were fully aware that they were dealing with a company and not the person of Salomon. Mr. Salomon being a separate entity from the company, he is not liable for the company’s debt; the company was rather liable to him as well.