Solomon v Solomon & Co. Ltd (1895-99)
Table of Contents
Human beings are generally legal person but humanity is a state of nature and legal personality is an artificial construct, which may or may not be conferred. The origin of corporation lies in a logical extension of this separation of humanity from legal personality as the group of humans who are engaged in a common activity could attempt to simplify their joint activity by gaining legal personality from the venture.
Solomon was a leather merchant who converted his business into a Limited Company as Solomon & Co. Limited (the ‘company’). The company so formed consisted on Solomon, his wife and five of his children as members. The company purchased the business of Solomon for £39,000; the purchase consideration was paid in terms of £10,000 debentures conferring a charge over the company’s assets, £20,000 in fully paid, £1 share each and the balance in cash.
The company in less than one year ran into difficulties and liquidation proceedings commenced. The assets of the company were not even sufficient to discharge the debentures (held entirely by Solomon himself). And nothing was left for unsecured creditors. The liquidator on behalf of unsecured creditors alleged that the company was a sham and mere alias or agent for Salomon.
Court of Appeal:
The British Court of Appeal considered the matter and Kay LJ stated that
“The statue was intended to allow seven or more persons, bona fide associated for the purpose of trade to limit their liability, under certain conditions and to become a corporation. But shareholders of Salomon & Co Ltd. were not intended to legalize the pretended association for the purpose of enabling an individual to carry on his business within; limited liability in the name of joint stock company.”
Thus, the focus of court of appeal was that the six family members never intended to take part in the business and only held the shares to fulfill the technicality required by the companies act.
House of Lords:
Lord Macnaghten held that ‘the company is different person altogether from subscribers… and, though it may be that after incorporation the business is precisely the same as it was before and same persons are managers, and same hand receive the profit, the company is not agent for subscriber or trustee for them. Nor are the subscribers as member liable, in any shape or form, except to the extent and manner prescribed by the Act.’
It can be summarized from the above discussion that the House of Lord unanimously held that the company had been validly constituted, since the Companies Act only required only seven (7) members holding at least one (1) share each. It said nothing about their being independent, or that there should be anything like a balance of power in the constitution of the company. Therefore, the business belonged to the company and not to Solomon rather Solomon was its agent. The company was not agent of Solomon.
The House of Lords lay down the following basic principles of a company:
The company is a juristic person; however, it does not possess the body of a natural being. It exists only in contemplation of law. Being an artificial person, it has to depend upon natural persons, namely, the directors, officers, shareholders, and corporate managers, etc., for its management and day to day running. However, these individuals only represent the company and accordingly whatever they do within the scope of the authority conferred upon them and in the name and on behalf of the company, they bind the company and not themselves.
One of the principal advantages of trading through the medium of a limited company is that the members of the company are only liable to contribute toward payments of its debts to a limited extent. If the company is limited by shares, the shareholders liability to contribute is measured by the nominal value of the shares he or she holds. In other words, once he or she or someone who held the shares previously has paid that nominal value plus any premium agreed on when the shares were issued, he is no longer liable to contribute anything further.
However, the companies may be formed with unlimited liability of members, or members may guarantee a particular amount. In such cases, liability of the members shall not be limited to the nominal or face value of their shares and the premium, if any, unpaid thereon. In the case of unlimited liability companies, members shall continue to be liable till the whole amount has been paid off. If a company is unable to pay its debts, its creditors may petition the court to wind it up.
These principles have been endorsed in many other cases, for instance, in the case of Lee v Lee’s Air Farming Limited, ‘L’ formed a company with a share capital of three thousand pounds, of which 2999 pounds were held by ‘L’. He was also the sole governing director. In his capacity as the controlling shareholder, ‘L’ exercised full and unrestricted control over the affairs of the company. ‘L’ was qualified pilot also and was appointed as the chief pilot of the company under the articles and drew a salary for the same. While piloting the company’s plane he was killed in an accident. As the workers of the company were insured, workers were entitled for compensation on death or injury. The question was while holding the position of a sole governing director could ‘L’ also be an employee/worker of the company. It was held that the mere fact, someone was the director of the company was no impediment to his entering into a contract to serve the company. If the company was a legal entity, there was no reason to change the validity of any contractual obligations which were created between the company and the deceased. The contract could not be avoided merely because ‘L’ was the agent of the company in its negotiations. Accordingly, ‘L’ was an employee of the company, and, therefore, entitled to compensation claim.
In view of above discussion, the chief advantage of incorporation from which all others follow is, of course, the separate legal entity. In reality, however, the business of the artificial person is always carried on by, and for the benefit of, some individuals. In the ultimate analysis, some human beings are the real beneficiaries of the corporate advantages, ‘for while, by fiction of law, a corporation is a distinct entity, yet in reality, it is an association of persons who are in fact the beneficiaries of corporate property’ – Gallaghar v. Germania Brewing Company.
It may, therefore, happen that the corporate personality of the company is used to commit frauds or improper illegal acts. Since an artificial person is not capable of doing anything illegal or fraudulent, the facade of corporate personality might have to be removed to identify the persons who are really guilty. This is known as lifting the corporate veil. Although, in general, the courts do not interfere and essentially go by the principle of separate entity as laid down in the Solomon’s case as discussed above.
However, with the passage of time, the courts come to realize that there can be fraudulent and mischievous schemes drawn by the promoters and members of the companies and the principle of Solomon’s case cannot be extended to each and every company. It may be in the interest of members in general, or in public interest to identify and punish the persons who misuse the medium of corporate personality. The circumstances under which the courts may lift the corporate veil may broadly be grouped under the following two heads:
The veil of corporate personality may be lifted in certain cases or pierced as per express provisions of the company law. In other words, the advantage of ‘distinct entity’ and ‘limited liability’ may not be allowed to be enjoyed in certain circumstances. Such cases may be:
Reduction of membership: If at any time, the number of members is reduced below the statutory minimum, and the companies carries on business beyond that minimum while the number is so reduced, the law can pierce the corporate veil under the relevant law and makes persons behind the company personally liable (in spite of their limited liability otherwise).
Misrepresentation in prospectus: In case of misrepresentation in a prospectus, every director, promoter and every other person, who authorizes such issue of prospectus, incurs liability toward those who subscribed for shares on the faith of untrue statement.
Mis-description of name: Where officer of a company signs on behalf of the company any contract, bill of exchange, or any kind of order of money, such person shall be personally liable if the name of the company is either not mentioned, or is not properly mentioned.
Fraudulent conduct: Where in case of winding up of the company by members of the company, it appears that any business of the company has been carried on with intent to defraud creditors of the company, or any other person, or for any fraudulent purpose, the court may hold such persons liable personally for any liability of the company.
Liability for ultra vires acts: Directors and other officers of a company will be personally liable for all those acts which they have done on behalf of a company if the same are ultra vires of the company.
It is difficult to deal with all the cases in which courts have lifted or might lift the corporate veil. Some of the cases where the veil of incorporation was lifted by judicial decisions may be discussed to form an idea as to the kind of circumstances. Here are some examples of it:
The Salomon principle held that the company was not an agent of its shareholders; however, it did not exclude the possibility of Agent-Principle relationship. The case was discussed in Smith, Stone & Knight Ltd vs. Birmingham Corp. the court observed that the company took over a business and continued it through a subsidiary company which was treated as department. Further, the parent company claimed compensation because of injury by the corporation’s use of its power of compulsory acquisition over the subsidiary land. Thus, subsidiary was agent, employee, or tool of the parent.
In Zaist v. Olson the court separated the fiction of capitalist control and actual control. It was held that ‘control not mere majority but complete domination, not only to finance but also to policy; such control must have been used by defendant to commit some wrong. The aforesaid control and breach of duty must proximately cause the injury or unjust loss complained of…’
It may, therefore, be concluded in the light of above discussion that though it is firmly established ever since Solomon’s case that a company is an independent and legal personality distinct from the individuals who are its members, it has since been held that the corporate veil may be lifted, the corporate personality may be ignored and the individual members recognized for who they are in certain exceptional circumstances. Generally, and broadly speaking the corporate veil may be lifted where the statute itself contemplates lifting the veil or fraud, or improper conduct is intended to be prevented. It is neither necessary nor desirable to enumerate classes of cases where lifting the veil is permissible, since that must necessarily depend on relevant statutory or other provisions, the object sought to be achieved, the impugned conduct, the involvement of element of public interest, the effect on parties who may be effected, etc. It is also noted that many of the recent developments in veil lifting have involved claims of tortious liability. Indeed tortious liability is one of the fault lines created by limited liability. Normal creditors when dealing with the limited liability company have an opportunity to access the risk of doing business. They can opt to secure their lending, charge a premium for that risk or do both.