“The decision of the House of Lords in Salomon v A Salomon and Co Ltd, where the court refused to hold the sole owner of the company’s shares liable for it’s debts, has stood the test of time”. – Gower’s Principles of Modern Company Law.
Critically discuss this statement.
The decision of the House of Lords in the case of Salomon to refuse to hold the sole owner of the company’s shares liable for it’s debts can be seen as a breakthrough in modern company law, in the sense that before this case, the doctrine of separate legal personality had not yet been fully recognised. This enables a company to sue or be sued in its own name, enter into contracts, hold its own property and be liable for the debts that it incurs. Additionally, this case further explicated the role of limited liability within the courts, this limits shareholders’ liability for the company debt to the amount they invested in the company (Davies & Worthington, 2016, p.191). These two doctrines are often described as the twin pillars of modern company law (Dahal, 2018) and a statement in Gower’s Principles of Modern Company Law expertly describes the relationship between these two doctrines: “if the separate legal personality of a company is ignored, there is no scope for the doctrine of limited liability, because nothing now stands between the creditors and the shareholders” (Davies & Worthington, 2016, p.198). As the statement declares that the decision in Salomon has stood the test of time, it comes into question what, in fact, is meant by “stood the test of time”. For the purpose of this essay, I have interpreted this statement to mean that the doctrine of separate legal personality has remained useful and valid in modern company law since its recognition in the case of Salomon over 120 years ago.
CA 2006 s16(2) asserts that once a company becomes incorporated it is considered a “body corporate”, with this legal status comes the right to separate legal personality. Until the case of Salomon, it was unclear to what extent, and in what circumstances, a company was thought to be legally separate from its members (Dahal, 2018). This doctrine can work to both the advantage and disadvantage of companies. For example, in the case of Lee v Lee the court held that a director and shareholder of a company could legally be employed by the company, due to the company and Mr Lee being two distinct legal entities, thus enabling Mrs Lee to claim compensation under the Workers’ Compensation Act 1922 after Mr Lee died in a plane crash. However, in the case of Macaura v Northern Assurance, the court ruled that Mr Macaura had no interest in the assets he had sold to his business, which later had been destroyed in a fire, and could therefore not make an insurance claim as they were insured in his own name. Despite the doctrines acting both for and against companies, it does not undermine their importance in modern company law, a point Karasz stresses in his statement, “The principle of separate legal personality, acquired upon the birth of the company, was and still is at the very nature of company law.” (Karasz, 2009, pp5).
The decision of the House of Lords in Salomon has remained highly controversial, Otto Kahn-Freund even went as far as describing it as a “calamitous decision” due to traders now being tempted to act as a limited company “even where no particular business risk is involved, and where no outside capital is required” (Kahn-Freund, 1944). There have been many challenges to the decision made in the case of Salomon, which could be seen to have eroded its value over time. One of the initial substantial challenges to the outcome of Salomon was the case of Daimler. This case ruled that a company with German shareholders and directors was an “enemy alien” during World War I and prohibited the company from trading in the UK. However, by identifying the nationality of the shareholders and directors of the company, the court was looking behind the corporate veil, going against the principles laid down in Salomon. Lord Parker refers to the doctrine of separate legal personality, stating that “No one can question that a corporation is a legal person distinct from its corporators”(Par 338), however, he then goes into to stress that the character of a company’s corporators is not irrelevant to the character of the company. Although the corporate veil was lifted in this case, it was due to a matter of national security rather than corporate personality (Dahal, 2018) and has only occurred due to the particularly extreme circumstances of a world war.
Another pinnacle case that challenged the principle laid down in Salomon was that of Adams v Cape. The premise of this case was the discussion over whether the separate legal personality of the subsidiary should be ignored in order to hold the parent company liable for obligations of the subsidiary towards involuntary tort victims (Davies & Worthington, 2016, p. 200). The court rejected all the arguments put forward to lift the corporate veil; a key argument put forward was the “single economic unit” argument. Slade LJ went against the earlier ruling of DHN, where a company group was considered to be a single economic unit, through stating, “there is no general principle that all companies in a group are to be regarded as one. On the contrary, the fundamental principle is that ‘each company in a group of companies’ is a separate legal entity” (Par 508). Slade LJ looked at the purpose of Cape’s corporate group structure to determine that there was no façade in how the company was formed and held that “Cape was in law entitled to organise the group’s affairs in that manner and … to expect that the court would apply the principle of Salomon” (Par 520), thus meaning that the US court had no jurisdiction to issue orders against the UK company. This strict following of the principles laid down in Salomon could be perceived as being highly beneficial for companies wishing to take advantage of manipulating the corporate structure of their group for the purpose of avoiding liabilities. Although this may not be equitable, it does not make the rule of Salomon any less valid at law.
A more recent challenge to the doctrine of separate legal personality came in the case of Prest v Petrodel, in which the court refused to lift the corporate veil under statue, by rejecting the argument put forward that the Matrimonial Causes Act 1973 authorised one party to the marriage to transfer an asset to the other which was not his to transfer (Par 40). Lord Sumption progressed the “façade or sham” condition presented in the case of Trustor to the “concealment and evasion” principle (Par 28). In particular, he enhanced the evasion principle by holding that ignoring the separate legal personality of the company would be justified only where the corporate form had been adopted in order to evade an already existing legal obligation. He makes reference to the cases of Gilford Motor Co v Horne and Jones v Lipman where “the real actors, Mr Horne and Mr Lipman, had a liability which arose independently of the involvement of the company” (Par 33). He contrasts this to the case of VTB Capital the court refused the argument to pierce the corporate veil as it would have created a new liability that would not have otherwise existed (Par 34). Although this does provide some clarity to the conditions under which the corporate veil can be pierced, it does, however, create more confusion as in both the cases of Gilford Motors and Jones the result could also have been achieved without the use of lifting the veil, “on the basis that the knowledge of the sole shareholder was to be imputed to the company.” (Davies & Worthington, 2016, p. 204). This does then cause the question to arise if the doctrine of piercing the veil is, in fact, a doctrine at all, a point of much discussion within the case. Lord Clarke states that “there is such a doctrine and that its limits are not clear” (Par 103), whilst Lord Walker makes his opinion known in his statement “I consider that ‘piercing the corporate veil’ is not a doctrine at all, in the sense of a coherent principle or rule of law” (Par 106).
Although there have been many challenges to the doctrine of separate legal personality since the decision of the House of Lords in Salomon, these have, in essence, not undermined the values identified by the House of Lords in the reasoning for the doctrine, but have, in fact, reinforced its importance and value in modern company law. At any instance that separate legal personality comes into question, the ruling of Salomon is always the first point of call. Only under extreme and specific circumstances can a court deviate from this outcome, this is seen by the principle of lifting the corporate veil only being triggered as a last resort, when all other options have been exhausted, epitomized by Lord Sumption in the case of Prest v Petrodel, stating “if it is not necessary to pierce the corporate veil, it is not appropriate to do so” (Par 35). This, combined with the fact that the case is still widely discussed both in the classroom and the courtroom after over 120 years, is the key evidence of how the decision of the House of Lords in the case of Salomon has truly stood the test of time.
References
Cases Referenced
Adams v Cape Industries Plc [1990] 1 Ch 443.
Daimler Co. ltd c Continental Tyre and Rubber Co (Great Britain) Ltd [1916] 2 AC 307.
DHN Food Distributors Ltd v Tower Hamlets London Borough Council [1976] 1 WLR 852.
Gilford Motor Co Ltd v Horn [1933] Ch. 935 CA.
Jones v Lipman [1962] 1 W.L.R. 832.
Lee v Lee’s Air Farming Limited [1960] UKPC 33, [1961] AC 12 (PC).
Macaura v Northern Assurance Co Ltd [1925] AC 619.
Prest v Petrodel Resources Limited and Others [2013] UKSC 34.
Salomon v A Salomon & Co Ltd [1897] AC 22 HL.
Trustor AB v Smallbone (No 2) [2001] 1 WLR 1177.
VTB Capital Plc v Nutritek International Corp [2013] UKSC 5.
Statutes Referenced
Companies Act 2003 s3
Companies Act 2006 s16
Matrimonial Causes Act 1973 s.24(1)(a)
Workers’ Compensation Act, 1922 (No. 39) (New Zealand), ss. 2, 3 (1)
Articles and Books Referenced
Dahal, R. (2018, May 10). Salomon v Salomon: Its Impact on Modern Laws on Corporations. Retrieved from https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3169431
Davies, P., & Worthington, S. (2016). Gower: Principles of Modern Company Law (10th Edition ed.). Sweet & Maxwell.
Kahn-Freund, O. (1944). Some Reflections on Company Law Reform. The Modern Law Review (7), 54.
Karasz, A. (2009). Corporate World Today: Courts Respond to Limited Liability and Board’s Decision Making – A Fight For a Justice or Rather Prosperity at Stake? . Common Law Review (10), 24. Retrieved from https://heinonline.org/HOL/Page?handle=hein.journals/comnlrevi10&div=10&g_sent=1&casa_token=&collection=journals