Part B Flashcards
What are the key facts of Salomon v Salomon Ltd
Mr Salomon owned a boot factory in Whitechapel in the 1890’s.
He set up a limited company and sold the boot business to the company for £39,000.
The company paid him £9,000 in cash and issued him with 20,000 shares at £1 each (cost £20,000).
To comply with the (then) Companies Act, the remaining shares were held by members of his family. Mr. Salomon lent the company the remaining £10,000 of the purchase price, and the debt was secured on the company’s property.
The new company got into financial difficulties & became insolvent.
Mr Salomon was entitled to be paid before the other unsecured creditors, so he got the £10,000 which he had lent to the company, but the unsecured creditors did not recover what was owed to them.
To avoid such alleged unjust exclusion, the liquidator, on behalf of the unsecured creditors, alleged that the company was sham, was essentially an agent of Salomon, and therefore, Salomon being the principal, was personally liable for its debt.
The liquidator sought to overlook the separate personality of Salomon Ltd., distinct from its member Salomon, so as to make Salomon personally liable for the company’s debt as if he continued to conduct the business as a sole trader.
What were the issues which the court faced?
Whether the company was a validly incorporated company.
Mr Salomon was liable for the company’s debts.
What did the HoL decide?
Company was validly incorporated in line with the CA 1862 -
How did HoL justify their decision?
Company was a separate legal person, which means that the loans resulting in debentures were payable back to him as a secured creditor.
Not relevant that the ownership of shares and management decisions were still Salomon, there is a distinct difference between a sole proprietor and company.
Why is the Salomon ruling so important?
Enshrined the concept of legal personality, meaning that the body corporate is distinct from the director. This is now reflected in modern company law such as CA 2006. Whilst legal personality had been considered in earlier cases, such as Re Raglan Hall Colliery in 1870 -, Salomon made the distinction very clear, as Lord McNaghten says, “The company is at law a different person altogether from the subscribers to the memorandum.”
As a consequence of legal personality, the Salomon ruling developed the concept of limited liability, a keystone for modern commerce, and a key driver for growth in businesses.
Finally, the Salomon ruling made it apparent that the one person company was an effective and legitimate business structure, which has in effect developed the most common form of LTD company today.
What does separate legal personality mean?
As Lord Denning stated, “That company are, in many ways, likened to a human body. They have a brain and a nerve centre which controls what they do.” It is a distinction between the body corporate and director/shareholder.
Companies, using their corporate personalities can;
Own assets in their own name
Enter into binding contracts in their own name
Engage in legal actions
What is limited liability?
Limited liability is exactly what it says on the tin, it reduces the risk for members and Directors, meaning that for example, they are not liable for debts to be paid out of their personal accounts.
LL gives an incentive for ventures which protects directors from potentially overbearingly high financial risks. It comes as a consequence of SLP.
What is the difference between separate legal personality and limited liability?
SLP - much more related to the detachment of a company from an individual or group, as it’s own distinct entity.
LL is a consequence of SLP, which focuses on the extent to which directors or shareholders are liable for the debts of a company.
What other cases have defined the bounds of separate legal personality?
Macaura v Northern Insurance
HOL held that an insurable interest must be met with a legal or equitable interest in that property. Wrenbury stated that no shareholder, creditor has legal or equitable assets in the corporation, they are owned solely by the body corporate.
Lee v Lee’s Air Farming LTD
Court found that because of the corporate veil, there was a distinction between the man and the company, meaning that compensation would be payable on the basis that he fulfilled the criteria in WCA 1922.
The company can contract with its own directors and shareholders because they are separate legal people, including hiring them as employees.
What does lifting the corporate veil mean?
Effectively means that the court will disregard the principle formed in Salomon, and disregard the SLP of the company (Prest v Petrodel, Antonio Gramsci Shipping v Recoletos LTD and Jones v Lipman)
How has lifting the corp veil developed?
Dignam and Lowry offer three helpful chapters of case development since Salomon 1897.
1897-1966 Classical Veil Lifting - HoL in Salomon ruling was dominant
Daimler v Conti Tyres (1916) - was Daimler Co in WW1s an enemy Germany?
Gilford Motor Co Ltd v Horne (1933)- The defendant attempted to avoid a restrictive covenant in competition by conducting business through a company set up by his wife. (A device/stratagem)
Jones v Lipman (1962) - Lipman entered into a binding contract to sell a plot of land to Jones, just before sale, he transfers land into a company and then claims impossible to transfer.
1966-1989 - The interventionist years - Salomon felt unjust in modern environment - pioneered by Lord Denning
Littlewoods Mail v IRC (1969) - Denning warned that Salomon wasn’t definitive and courts can pierce the veil if they feel appropriate
DHN Food v Tower Hamlets (1976) - group of companies should be treated as a single economic entity
1989-present - reconsideration of the law, but reaffirmed trust in the principle
Adams v Cape Industries 1990 - significantly narrowed conditions for lifting corporate veil. ruled that the conditions for piercing the veil in cross border legal issues were very specific.
In sum, the decision in Adams narrows the situations where the veil of incorporation is in effect lifted to three main situations.
(a) Where the company is a mere façade.
(b) Where the court is interpreting a statute or document in order to reject fairness.
(c) Where the subsidiary is an agent of the company.
Additionally, this solution has been followed in cases such as Connelly v RTZ Corp Plc (1998)18, Ord v Belhaven Pubs Ltd (1998)19, and Lubbe v Cape Industries Plc (2001)20.
Prest v Petrodel Resources LTD - 2013 established that piercing will only be done when there is an evasion of a legal obligation, and only then when there is an advantage that is only gained and no other remedy that would achieve that purpose. SC accepted that there is a principle of English law enabling the court to pierce the corporate veil without statutory provision.
Do you think the SLP creates unfair or harsh results?
/
Why did Otto Kahn Freud describe it as a calamitous decision?
Separate Legal Personality (SLP) presents significant economic potential for society, particularly in ventures, investments, and entrepreneurship.
The question arises: Would today’s innovative unicorns, which have improved our lives, have emerged if their founding directors faced personal liability for debts?
However, it’s crucial to acknowledge the minority of cases where individuals exploit loopholes in the commercial realm, such as Philip Green of Arcadia Group, highlighting the darker side of SLP’s offerings and the inadequacy of legislation in enforcing accountability against such exploitation.
Does not give an effective remedy to shareholders or creditors when companies fail, which can lead to significant, sometimes and systemic negative externalities.
1- SLP was designed for venture capitalists in the 19th century to take commercial risks, rather than for the whole corporate law ecosystem to be afforded the ‘unyielding rock’ which Templeman described it as.
2 - Gives an overbearing protection afforded to individuals who have caused harm to others through financial loss, which is undeserved. It doesn’t promote a culture of corporate social responsibility.
3 - Failed, at the time, to give adequate protection to business creditors, and disincentivises lending.
4 - The central problem with the Salomon principle is an ethical one. If Aron Salomon’s property is protected then people dealing with the company have only got the company’s own assets available to them if the company goes into insolvency. This means that an entrepreneur in the position of Aron Salomon may give less care and attention to the need to deal honestly and fairly with third parties because the entrepreneur faces no great personal risk of loss, beyond wounded pride and the hope of a profitable business (except what is said below about fraudulent trading).
When and why would courts consider piercing the corporate veil?
WHEN
Corporate personality will be cast aside where a company is a sham or is used to evade a contractual obligation.
Gilford Motor Co Ltd v Horne 1933- The defendant attempted to avoid a restrictive covenant in competition by conducting business through a company set up by his wife.
Jones v Lipman 1962 - Lipman entered into a binding contract to sell a plot of land to Jones, just before sale, he transfers land into a company and then claims impossible to transfer.
Where a company has been set up to evade a legal obligation, showing serious impropriety linked to the corporate structure. (Petrodel v Prest) [2013]
Mrs Prest was awarded a divorce settlement of £17.5 million, but most of Mr Prest’s assets were tied up in companies that he controlled. Mrs Prest argued that the corporate personalities of these companies should be pierced. This was in the absence of any effective alternative remedy.
WHY
Corporate veil can create unfair results and finding a way around it offers a fair recourse
Disincentivizes fraudulent behaviour
Useful commercial tools, promotes investment certainty for investors
Ways around / Statutory exceptions to lifting the veil and therefore losing limited liability?
1 - Taxation
Where there have been breaches of obligations to produce accounts s399 CA 2006 or of the obligation to provide details of subsidiaries (s309 CA 2006).
2 - Corporate insolvency
Fraudulent trading during the wind up process under s213 Insolvency Act 1986 - required actual dishonesty as per Re Patrick v Lyon LTD 1933
Wrongful trading during the wind up process under s214 IA 1986
3) Pre-incorporation contracts
Contracts - particularly where lenders ask for guarantees for finance from directors. As a result, directors become liable for significant financial risks attached to specific lending terms. A guarantee is a contractual promise to pay the debts of a 3rd part if the business fails.
