The case of Salomon and Salomon & Co Ltd
The case of Salomon vs Salomon & Co Ltd revolves around Mr. Salomon, a successful leather merchant. His business was sound condition and there were surplus assets over the liabilities. In 1892, Salomon decided to incorporate his business as a limited company, Salomon & Co Ltd. At that time, the Companies Act of 1862 required the presence of at least seven shareholders. Salomon registered his family members as the shareholders issuing one share to each of them. The business was transferred to new incorporation for $40000. Salomon took his payment in the form of shares and a debenture of $10000. He owned 20000 each $1 shares, these debentures indicated that company owed Salomon $10000 thus making him the company’s principal shareholder and principal creditor. This implied that Salomon personal liability for the debt changed from unlimited liability to limited liability. However, the company went into liquidation within a year. After paying the debentures, nothing was left for the creditors. The liquidator filed a case arguing that debentures used by Salomon as the security for debt were invalid.
What the High court believed
In the circumstances of the case, the High Court and a strong Court of Appeal held that Salomon violated the principles of the corporation and unlimited liability as outlined by the Companies Act of 1862. They argued that the incorporation of the company was invalid as the law required independent bona fide shareholders, who could not be easily manipulated. Since the company consisted of family members as the shareholder, they could be easily manipulated by Salomon. Therefore, the Court of Appeal ruled that the company had no separate legal entity from Salomon. As such, he was liable to indemnify the corporation against its debts.
However, the House of Lords overturned the decision of the Court of Appeal. The House lords argued that a corporation formed in compliance with the Companies Act is a separate legal entity. It held that Salomon followed a legal procedure to establish the company; shares and debenture were used. The law required seven shareholders holding at least one share each. By issuing the shares and debentures, the Salomon personal liability changed from unlimited liability to limited liability. This meant that Salomon had no personal liability to the company’s debts. The company was a separate legal entity but not an agent or trustee of the shareholders. Therefore, it was unlawful to label the shareholders as dummies since the company was formed according to the law.
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