Limited Liability and Salomon v Salomon

The seed was sown by the Limited Liability Act 1855; Limited Liability did not become part of the law relating to the companies incorporated by registration until the 1855 Act was passed. [1]

The principle of limited liability already applied to companies incorporated by royal charter or by specific Acts of Parliament. [2] The problem with incorporation by such means was due to the fact that the Crown and Parliament were rather hesitant and suspicious of lending their dignity and the benefits of corporate personality to any commercial organisations, thus imposed procedural and cost deterrents.

The Limited Liability Act permitted any registered company (other than insurance companies) to limit the liability of its company debts to their members amount of share capital which they had invested, provided the company put ‘limited’ or ‘ltd’ as the last word to its name. [3]

In addition to the application of ‘limited’ as the concluding word to a company’s name the 1855 Act required at least twenty-five members and a minimum subscribed capital (minimum par value was equal to £10). [4] Such prerequisites were considered safeguards of the Act and barriers to the rise in criticism that the Limited Liability Act bore unparalleled risk to company creditors; it was believed that the Limited Liability Act would distort markets.

The 1855 Act was later repelled and incorporated into the 1856 Joint Stock Companies Act where many of the earlier safeguards were removed.

The requisite of at least twenty-five members with a minimum subscribed capital was reduced to an initial value of seven or more persons to sign and register a memorandum of association. [5]

THE MODERN LIMITED LIABILITY COMPANY

This new constitutional framework marked the beginning of the modern limited liability company. [6] The Joint Stock Act ‘created a wholly revised system which has been developed by successive Companies Acts ever since’ [7] ; requiring two new documents for incorporation, namely, the memorandum of association and the articles of association.

The memorandum of association ‘contains the fundamental provisions of the company’s constitution’ [8] , in many respects it is a statement made by each subscriber confirming the company’s name, domicile and each respective subscriber’s share capital, and whether the company is limited or unlimited, public or privately traded. [9] ‘The articles of association, on the other hand, deal with matters of internal management of the company such as procedures for a general meeting or board of directors’ meeting, the appointment and removal of directors and other items such as the payment of dividends .’ [10]

Subsequent acts after the 1856 legislation only reaffirmed the introduction and entrenchment of the modern limited company in UK company law. The provision of limited liability was no longer an honorary grant of royal charter or by specific Act of Parliament.

Previously where insurance companies were not permitted to register with limited liability under the 1856 enactment this was revoked by the latter Companies Act 1862. [11] Hicks and Goo note that prior to 1956, 956 companies were registered under the Joint Stock Companies Act 1844 [12] , although in the successive six years after the 1956 Act no fewer than 2,479 companies were registered, now with limited liability. [13]

The era of limited liability had materialised and so too the practice of incorporating ‘private’ companies. Traditional sole trade companies (an individual in business on his or her own) would locate six nominees to form the required seven subscribers and incorporate their company. [14] For their efforts the company achieves separation of business and private affairs, specifically corporate personality [15] and, more significantly, limited liability. [16]

SALOMON v SALOMON

Arguably, the implication of the immense popularity of corporate personality and the ‘limited’ status was only acknowledged by the UK courts in the late stage of its development, it was not until the end of the nineteenth century that this implication was visualised in the celebrated case of Salomon v A Salomon and Co Ltd.

The of the Salomon case were as follows: Aron Salomon had initially carried out business as a leather merchant and boot manufacturer respectfully, as a sole trader. Depression in the boot trade led to Mr. Salomon forming a limited company to purchase his business whilst reserving control over the conduct of the business.

Salomon formed A Salomon Ltd, a limited company with other members of his family; the memorandum of association was subscribed by himself, his wife, his daughter, and four of his sons, for one share each, accumulating the seven shares required by the Companies Act 1862.

The company, A Salomon Ltd, purchased Mr. Salomon business for an approximate value of £39,000 of which Aron Salomon alleged the company retained £20,000 in return for the 20,001 of the 20,007 (£1 nominal value) shares held by Mr. Salomon. The remaining six shares were respectively held by the associated members of his family.

Notwithstanding the above, Mr. Salomon further also received a floating security debenture of £10,000 and some £9000 balance owed from the sale was paid to him in cash.

The company continued under the management of Mr. Salomon as managing director, although still continued to fall upon hard times. In an effort to save the business Mr. Salomon transferred his debentures to a Mr. Edmund Broderip in return for £5000. Salomon then lent the £5000 back to the company, charging 10% interest. Despite the efforts of Mr. Salomon to keep the company afloat,

A Salomon Ltd fell into an insolvent state and less than a year after its formation an order was made for the company to be wound-up (at this stage the company’s said worth was approximately £6000).

The assets at that time were just sufficient to discharge the debentures, Broderip, as a secure creditor, appointed a receiver and manager to enforce his security and were ultimately paid the approximate £5000 owed. Nothing was left for unsecured creditors with debts as Mr. Salomon aimed to rely on his equitable interest in the debentures and claim for the remaining £1000 of the company’s assets. Salomon’s argument was that he should be treated as a secure creditor and paid ahead of unsecure creditors. The creditors claimed that they should have priority because in many respects Mr. Salomon and the company were the same person.

THE HIGH COURT and THE COURT OF APPEAL

At first instance, Vaughan Williams J, proposed that the company was Mr. Salomon’s business and no one else’s; Mr. Salomon chose to employ as agent, A Salomon limited. [17] The learned judge admitted ‘that upon its registration a company was a legal entity, distinct from its corporators’ [18] and opined that as per the ordinary regulations of agency and agent, Mr. Salomon is bound to indemnify that agent: A Salomon Ltd. [19]

Similarly, the Court of Appeal upheld the decision of Vaughan Williams J. The Court of Appeal ‘sought to ignore the legal personality of the [company] and visit the liability on the human personalities behind the corporation. [20] Although did so via a different analogy.

Broderip v Salomon [1985] did not negate the fact that the Companies Act 1862 stipulated that ‘a man may become what is called a private company’ [21] however, unanimously the judges sitting agreed the merits of the case meant the company was at best a ‘mere alias’ [22] of Mr. Salomon.

Lopes LJ aimed to clarify that the 1862 statute never intended a company to be constituted and consist of one substantial person and six mere dummies without, any real interest in the company. [23]

Lindley further supported reasoning and held: [24]

There can be no doubt that in this case an attempt had been made to use the machinery of the Companies Act 1862 for the purpose for which it was never intended. The legislature contemplated the encouragement of trade by enabling a comparatively small number of persons – namely, not less than seven – to carry on business with a limited joint stock or capital, and without the risk of liability beyond the loss of such joint stock or capital. But the legislature never contemplated an extension of limited liability to sole traders or to a fewer number than seven.

Notwithstanding the above, Lindley LJ, presumed a new analogy, proposing that the manner in which the company was incorporated could only suggest that its formation was for illegitimate purposes; A Salomon Ltd was a merely device to defraud creditors. [25]

THE HOUSE OF LORDS

The House of Lords unanimously overturned this decision, upholding Aron Salomon’s appeal, rejecting the arguments from agency and fraud. According to the House, the Companies Act 1862 was concise and definitive: ‘a company could be incorporated providing it had at least seven members, irrespective of whether all seven members made a substantial contribution to the company.’ [26]

The House of Lords desired to reaffirm the principle which the lower courts abstained to adhere; the principle of independent existence of corporations separate from that of their corporators.

Lord Halsbury L.C. held: [27]

I must pause here to point out that the [1862] statute enacts nothing as to the extent or degree of interest which may be held by each of the seven, or as to the proportion of interest or influence possessed by one or the majority of the share-holders over the others. …[I]t seems to me impossible to dispute that once the company is legally incorporated it must be treated like any other 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.