Case Study: Salomon v. A. Salomon and Co. Ltd.

By Sahil Kumar 10 Minutes Read

Citation: [1897] A.C. 22 (H.L.)

Court: House of Lords

Date of Judgement: November 16, 1896

Bench: Lord Halsbury, Lord Watson, Lord Herschell, Lord Macnaghten, Lord Davey, Lord Morris

Facts

• Mr. Salomon operated a business specializing in leather boots and shoes. His family wanted to be partners and enter the business with him. So, In 1892, he founded a company named “Salomon and Company Ltd.”
•  Each of his family members, including his wife, a daughter and four sons, held one share each in the company, as the law mandated a minimum of seven shareholders. Additionally, Mr. Salomon assumed the role of managing director within the company. This newly established entity proceeded to acquire the existing sole trading leather business.
• Mr. Salomon valued his business at ₤39,000 and held 20,001 shares in the company, with the remaining 6 shares being held by his family. Additionally, he acted as a secured creditor due to a debenture he held in the company. To finance the business, Salomon had borrowed funds from creditors.
• Unfortunately, the leather business faced difficulties, prompting Salomon to sell his debenture within a year to salvage the company. Despite his efforts, the company was unable to recover, leading to its insolvency.
• The liquidator, representing unsecured creditors, contended that the company functioned as an agent for Salomon, thus holding him personally liable for the company’s debt.

Decision of the Court of Appeal

The Court of Appeal ruled that the entire transaction went against the genuine purpose of the Companies Act, deeming the company a mere facade and affirming that Salomon continued to be the true owner of the business. Consequently, Salomon was obligated to compensate the company for its trading debts.

Decision of the House of Lords

The House of Lords reversed the Judgment of the court of appeal on the grounds that the company was valid and legally founded. The House of Lords further concluded that a shareholder/controller cannot be held liable for the debts incurred by the company. The reverse appeal by the liquidator was dismissed with court costs.

Key legal issues discussed

• Whether Salomon and Co. Ltd. was a valid company?

Yes

According to the Companies Act,^[1] “Any seven or more persons associated for any lawful purpose may, by subscribing their names to a memorandum of association, and otherwise complying with the requisitions of this Act in respect of registration, form an incorporated company, with or without limited liability.”^[2] Lord Halsbury pointed out that the court must follow what the statute says. He propounded that the court does not have the power to make any additions to a statute but take it as the sole guide.^[3] He pointed out that there existed 7 shareholders and the statute does not specify as to how many shares each shareholder must hold in order to be considered a shareholder.

Section 8 of the statute states “no subscriber shall take less than one share.”^[4] Lord Halsbury also criticized Judge Vaughan Williams by saying that he contradicted himself by saying that the company is a legal identity and still held Mr. Salomon liable. Lord Halsbury further added, “I confess it seems to me that that very learned judge becomes involved by this argument in a very singular contradiction. Either the limited company was a legal entity or it was not. If it was, the business belonged to it and not to Mr. Salomon. If it was not, there was no person and nothing to be an agent at all; and it is impossible to say at the same time that there is a company and there is not.”^[5]

• Whether a shareholder/controller can be held liable for the debts of the company?

No

“Persons who purchase property and then create a company to purchase from them the property they possess, stand in a fiduciary position towards that company, and must faithfully state to the company the facts which apply to the property, and would influence the company in deciding on the reasonableness of acquiring it.”^[6]

Lord Halsbury pointed out that in this case, every member of the company, every shareholder, knew exactly what is the true state of the facts and no case of fraud can be established upon the company. Since, there was no fraud or agency and the company was a real one and not a fiction or a myth the judgment of the court of appeal shall be disposed of. Lord Watson said “The unpaid creditors of the company, whose unfortunate position has been attributed to the fraud of the appellant, if they had thought fit to avail themselves of the means of protecting their interests which the Act provides, could have informed themselves of the terms of purchase by the company, of the issue of debentures to the appellant, and of the number of shares held by each member.”

Lord Watson further stated that whatever moral duty of a limited company may be, no statute or section in the British legal system obliges them to warn the members of the public who deal with them on credit. He agreed with Lord Halsbury and recited that the apathy of a creditor cannot justify an imputation of fraud against a limited company or its members, who have provided all the means of information which the act of 1862 requires. He further recited that a creditor who chooses not to take the trouble to use the means which the statute provides for enabling him to protect himself must bear the consequences of his own negligence.

Lord Herschell also concurred with the opinions of Lord Halsbury and Watson and stated “There is certainly nothing unlawful in the creation of such debentures.”^[7] Lord Macnaghten recited the case of In re Baglan Hall Colliery Co.^[8] and stated “In this case, there was no fraud or misrepresentation and nobody was received.” Lord Davey stated that a company may contract with the holder of the bulk of its shares, and such contract will be binding though carried by the votes of that shareholder.^[9] Lord Morris Concurred with the judgment of the lords.

^[1] The Companies Act, 1862 (25 & 26 Vict. c. 89), Acts of Parliament, 1862(United Kingdom)

^[2] Section 6 Companies Act, 1862

^[3] Lord’s Journals, November 16, 1896 Pg. 29

^[4] The Companies Act, 1862 (25 & 26 Vict. c. 89), Acts of Parliament, 1862(United Kingdom)

^[5] Lord’s Journals, November 16, 1896 Pg. 31

^[6] Erlanger v. New Sombrero Phosphate Co.

^[7]  Lord’s Journals, November 16, 1896 Pg. 47

^[8] L. R. 5 Ch. 346

^[9] North west transportation co. v. Beatty 12 App. Cas. 589

Sahil Kumar