Salomon v A Salomon and Co Ltd [1897] AC 22 Case Summary

The requirements of correctly constituting a limited company

Introduction

Separate Legal Personality (SLP) is the basic tenet on which company law is premised.
Establishing the foundation of how a company exists and functions, it is perceived as, perhaps,
the most profound and steady rule of corporate jurisprudence. Contrastingly, the rule of “SLP”
has experienced much turbulence historically, and is one of the most litigated aspects within
and across jurisdictions.1 Nonetheless, this principle, established in the epic case of Salomon v
Salomon,2 is still much prevalent, and is conventionally celebrated as forming the core of, not
only the English company law, but of the universal commercial law regime.

Commonly known as: Salomon v Salomon

FACTS

Salomon transferred his business of boot making, initially run as a sole proprietorship, to a
company (Salomon Ltd.), incorporated with members comprising of himself and his family. The
price for such transfer was paid to Salomon by way of shares, and debentures having a floating
charge (security against debt) on the assets of the company. Later, when the company’s
business failed and it went into liquidation, Salomon’s right of recovery (secured through
floating charge) against the debentures stood aprior to the claims of unsecured creditors, who
would, thus, have recovered nothing from the liquidation proceeds.

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. In other words, 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.

ISSUE

The case concerned claims of certain unsecured creditors in the liquidation process of Salomon
Ltd., a company in which Salomon was the majority shareholder, and accordingly, was sought
to be made personally liable for the company’s debt. Hence, the issue was whether, regardless
of the separate legal identity of a company, a shareholder/controller could be held liable for its
debt, over and above the capital contribution, so as to expose such member to unlimited
personal liability.

RULING

The Court of Appeal, declaring the company to be a myth, reasoned that Salomon had
incorporated the company contrary to the true intent of the then Companies Act, 1862, and
that the latter had conducted the business as an agent of Salomon, who should, therefore, be
responsible for the debt incurred in the course of such agency.

The House of Lords, however, upon appeal, reversed the above ruling, and unanimously held
that, as the company was duly incorporated, it is an independent person with its rights and
liabilities appropriate to itself, and that “the motives of those who took part in the promotion
of the company are absolutely irrelevant in discussing what those rights and liabilities are”.3
Thus, the legal fiction of “corporate veil” between the company and its owners/controllers4
was firmly created by the Salomon case.
IMPLICATIONS

Commencing with the Salomon case, the rule of SLP has been followed as an uncompromising
precedent5 in several subsequent cases like Macaura v Northern Assurance Co.6, Lee v Lee’s Air
Farming Limited,7 and the Farrar case.8

The legal fiction of corporate veil, thus established, enunciates that a company has a legal
personality separate and independent from the identity of its shareholders.9 Hence, any rights,
obligations or liabilities of a company are discrete from those of its shareholders, where the
latter are responsible only to the extent of their capital contributions, known as “limited
liability”.10 This corporate fiction was devised to enable groups of individuals to pursue an
economic purpose as a single unit, without exposure to risks or liabilities in one’s personal
capacity.11 Accordingly, a company can own property, execute contracts, raise debt, make
investments and assume other rights and obligations, independent of its members.12
Moreover, as companies can then sue and be sued on its own name, it facilitates legal course
too.13 Lastly, the most striking consequence of SLP is that a company survives the death of its
members.14

The Exception of Veil Piercing

Notably, similar to most legal principles, the overarching rule of SLP applies with exceptions,
where the courts may look through the veil to reach out to the insider members, known as
“lifting or piercing of the corporate veil“.15

It is worthwhile here to refer to the case of Adams v Cape Industries16, which examined the
common law grounds, primarily evolved through case law as an equitable remedy,17 namely-
(a) agency, (b) fraud, (c) façade or sham, (d) group enterprise, and (e) injustice or unfairness.
The exception has been invoked widely by English courts, including in the recent cases of
Caterpillar Financial Services (UK) Limited v Saenz Corp Limited, Mr Karavias, Egerton Corp.18,
Beckett Investment Management Group v Hall,19 Stone & Rolls v Moore Stephens,20 and Akzo
Nobel v The Competition Commission,21 to cite a few. Needless to mention, the journey of
English law in defining the contours of the SLP doctrine and carving out these exceptions has
been quite topsy-turvy. Moreover, veil piercing is now also rampant as a statutory exception.22

So, considering the gamut of statutory and judge made exceptions above, has the Salomon rule
become redundant?

March back to the Salomon rule

While the Salomon rule appears to have been eroded substantially, a reversal in the judiciary’s
approach, commencing with the Adams case, is now visible.

For instance, in Bank of Tokyo v Karoon,23 the Court of Appeal rejected the “single economic
unit” theory arguing that “we are concerned not with economics but with law. The distinction
between the two is, in law, fundamental and cannot here be abridged”. Further, in the case of
VTB Capital Plc v Nutritek International Corporation,24 the court reiterated the restricted scope
of veil piercing as only a limited equitable remedy.

On a similar note, in the most recent judgment of Prest v Petrodel25, Sumption J. confined the
lifting of veil to only two situations, namely, (a) the “concealment principle”, akin to the sham
or façade exception; and (b) the “evasion principle”, being the fraud exception.26 Deciding not
to pierce the corporate veil on the facts, this case once again reinstated the Salomon rule.
Conclusion

All in all, the Salomon ruling remains predominant and continues to underpin English company
law. While sham, façade and fraud primarily trigger the invocation of the veil piercing exception
in limited circumstances, these grounds are not exhaustive, and much is left to the discretion
and interpretation of the courts on case-to-case basis