Mr. Aron Salomon was a British leader merchant who for many years operated a sole proprietor business, specialized in manufacturing leather boots. In 1892, his son, also expressed interest in the businesses. Salomon then decided to incorporate his businesses into a limited company, which is Salomon & Co. Ltd. However, there was a requirement at the time that for a company to incorporate into a limited company, at least seven persons must subscribe as shareholders or members.
Salomon honored he clause by including his wife, four sons and daughter into the businesses, making two of his sons directors, and he himself managing director. Interestingly, Mr. Salomon owned 20,001 of the company's 20,007 shares - the remaining six were shared individually between the other six shareholders. Mr. Salomon sold his business to the new corporation for almost £39,000, of which £10,000 was a debt to him. He was thus simultaneously the company's principal shareholder and its principal creditor. At the time of liquidation of the company, the liquidators argued that the debentures used by Mr. Salomon as security for the debt were invalid, and that they were based on fraud.
Vaughan Williams J. accepted this argument, ruling that since Mr. Salomon had created the company solely to transfer his business to it, the company was in reality his agent and he as principal was liable for debts to unsecured creditors. The lord justices of appeal variously described the company as a myth and a fiction and said that the incorporation of the business by Mr. Salomon had been a mere scheme to enable him to carry on as before but with limited liability. However, the House of Lords later quashed that Court of Appeal (CA) ruling, upon critical interpretation of the 1862 Companies Act.
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The court unanimously ruled that there was nothing in the Act about whether the subscribers (i.e. the shareholders) should be independent of the majority shareholder. The company was duly constituted in law, the court ruled, and it was not the function of judges to read into the statute limitations they themselves considered expedient. The 1862 Act created limited liability companies as legal persons separate and distinct from the shareholders.
In other words, by the terms of the Salomon case, members of a company would not automatically, in their personal capacity, be entitled to the benefits nor would they be liable for the responsibilities or the obligations of the company. It thus had the effect that members' rights and/or obligations were restricted to their share of the profits and capital invested.
Significance of the Salomon Case
The rule in the Salomon case that upon incorporation, a company is generally considered to be a new legal entity separate from its shareholders has continued till these days to be the law in Anglo-Saxon courts, or common law jurisdictions. The case is of particular significance in company law thus: Firstly, it established the canon that when a company acts, it does so in it's own name and right, and not merely as an alias or agent of it's owners.
For instance, in the later case of Gas Lighting Improvement Co Ltd v Inland Revenue Commissioners, Lord Sumner said the following: "Between the investor, who participates as a shareholder, and the undertaking carried on, the law interposes another person, real though artificial, the company itself, and the business carried on is the business of that company, and the capital employed is its capital and not in either case the business or the capital of the shareholders. Assuming, of course, that the company is duly formed and is not a sham...the idea that it is mere machinery for affecting the purposes of the shareholders is a layman's fallacy. It is a figure of speech, which cannot alter the legal aspect of the facts."
Secondly, it established the important doctrine that shareholders under common law are not liable the company's debts beyond their initial capital investment, and have no proprietary interest in the property of the company. This has been affirmed in later cases, such as in The King v Portus; ex parte Federated Clerks Union of Australia, where Latham CJ while deciding whether or not employees of a company owned by the Federal Government were not employed by the Federal Government ruled that: "The company…is a distinct person from its shareholders. The shareholders are not liable to creditors for the debts of the company. The shareholders do not own the property of the company…"" II Piercing of the veil by Common Law Courts
Lifting the veil of incorporation or better still; "Piercing the corporate veil" means that a court disregards the existence of the corporation because the owners failed to keep one or more corporate requirements and formalities. The lifting or piercing of the corporate veil is more or less a judicial act, hence it's most concise meaning has been given by various judges. Staughton LJ, for example, in Atlas Maritime Co SA v Avalon Maritime Ltd (No 1) defined the term thus: "To pierce the corporate veil is an expression that I would reserve for treating the rights and liabilities or activities of a company as the rights or liabilities or activities of its shareholders.
To lift the corporate veil or look behind it, therefore should mean to have regard to the shareholding in a company for some legal purpose." Young J, in Pioneer Concrete Services Ltd v Yelnah Pty Ltd, on his part defined the expression "lifting the corporate veil" thus: "That although whenever each individual company is formed a separate legal personality is created, courts will on occasions, look behind the legal personality to the real controllers." The simplest way to summarize the veil principle is that it is the direct opposite of the limited liability concept. Despite the merits of the limited liability concept, there is the problematic that it can lead to the problem of over inclusion, to the disadvantage of the creditors. That is to say the concept is over protected by the law.
When the veil is lifted, the owners' personal assets are exposed to the litigation, just as if the business had been a sole proprietorship or general partnership. Common law courts have the lassitude or exclusive jurisdiction "lift" or "look beyond" the corporate veil at any time they want to examine the operating mechanism behind a company. This wide margin of interference given common law judges has led to the piercing of the corporate veil becoming one of the most litigated issues in corporate law.
But it should be worthy of note that a rigid application of the piercing doctrine in common law jurisdictions has been widely criticized as sacrificing substance for form. Hence, Windeyer J, in the case of Gorton v Federal Commissioner of Taxation, remarked that this approach had led the law into "unreality and formalism."
As aforementioned, when the judges pierce the veil of incorporation, they accordingly proceed to treat the company's members as if they were the owners of the company's assets and as if they were conducting the companies business in their personal capacities, or the court may attribute rights and/or obligations of the members on to the company. The doctrine is also known as "disregarding the corporate entity". In his 1990 article, Fraud, Fairness and Piercing the Corporate Veil, Professor Farrar remarked that the Commonwealth authority on piercing the corporate veil as "incoherent and unprincipled".
That claim has been earlier backed up by Rogers AJA, a year ago in the case of Briggs v James Hardie & Co Pty thus: "There is no common, unifying principle, which underlies the occasional decision of the courts to pierce the corporate veil. Although an ad hoc explanation may be offered by a court which so decides, there is no principled approach to be derived from the authorities."
Another scholar in the person of M. Whincop in his own piece: 'Overcoming Corporate Law: Instrumentalism, Pragmatism and the Separate Legal Entity Concept', argued that the main problem with the Salomon case was not so much the argument for the separate legal entity, but rather the failure by the English House of Lords to give any indication of "What the courts should consider in applying the separate legal entity concept and the circumstances in which one should refuse to enforce contracts associated with the corporate structure."
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