The History of Aaron Salomon Case - Essay Example

Salomon v Salomon & Co [1897] AC 22 Introduction The decision made by the House of Lords regarding Salomon vSalomon & Co Ltd confirms Gooley’s observation that indeed, the separation of legal entity doctrine was a “double-edged sword” (Googey, 1995). On the level ground, it was a near perfect decision. Though Salomon’s case, the separation of corporations as different legal entities was established. This gave the business all the necessary features and elevated it to turn into a driving force of capitalism. In some instances, it was a bad decision because provided loopholes for fraud and evasion of legal obligations. This paper will discuss the rationale and the impact of the decision made by the House of Lords regarding Salomon v Salomon & Co Ltd on company law. The History of Aaron Salomon Aaron Salomon was a businessman who for many years worked in manufacturing leather boots. Increasingly, his sons grew and demanded to be part of the business. Consequently, Salomon capitulated and incorporated his manufacturing business as Limited Liability Company. During those times, one needed to have at least seven members in order to incorporate their business. Salomon registered all his family members as shareholders of the business. Salomon, however, owned a majority of the company’s shares while the rest of the family members shared the minority shares equally. Consequently, Salomon became not only the company’s principal shareholder but also the company’s principal creditor (Duhaime, 2010). The decision at first instance: Broderip v Salomon Upon incorporation of the business, the company saw a decline in the sales of the boots. Part of the resolve for the waning was as a consequence of a sequence of internal strikes. The strikes made the government, Salomon’s main customer, divide its contracts to other firms in order to avoid the risk of depending heavily on one supplier. The government’s decision to divide its contract among other firms affected Salomon’s business greatly and was one of the reasons it failed. The consequence of failure was the inability of the company to pay interest on its debentures (half-held by Broderip). Broderip took action and litigated to apply his safety in the year 1983. It is after the company failed that it was put into liquidation (Duhaime, 2010). While in liquidation, the liquidator became suspicious of Salomon’s debentures used for security for the debt. He termed them as invalid and argued that Salomon obtained them fraudulently. As such, the liquidator demanded a refund of the money that had been dished out to Salomon by the company and a cancellation of the debentures. The liquidator’s argument was because Salomon sold his business at an exorbitant price and thus breached his fiduciary duty. In addition, the liquidator also contended that the company creation was a deception contrary to its unsecured creditors. The presiding judge accepted These arguments because being the principle shareholder and creditor, Salomon was to be held liable for debts to unsecured creditors (Googey, 1995). The decision of the High Court and Appellate court Initially, the case was filed as Broderip v Salomon in which Vaughan Williams confirmed the validity of the case (Gower, 2008). In the ruling, Williams clearly stated that the company claim of having indemnity against Salomon was right. He also asserted that the signatories to the memorandum were quite uninformed, a fact that Salomon used to make a fool of them. The judge’s view of the company was that it was a masquerade that represented the interests of Salomon fully. As a result, the company had a full entitlement to protection from the principle. The liquidator managed to amend the counter-claim, and this saw them awarded for indemnity (Gower, 2008). The case progressed to the court of appeal. Here, the court also ruled in favour of the liquidator’s arguments after it found Salomon to have breached the privileges of not only incorporation but also limited liability. In their ruling, the lord honesties held the view that the company was a fiction. Moreover, the amalgamation of the occupational by Mr. Salomon was a creative way of enabling him conduct his business like he used to previously, however, with limited liability (Griffin, 1996). House of Lords conclusion in Salomon v Salomon & Co Ltd The House of Lords overturned the decision made by the court of appeal; consequently making the arguments the previous arguments null and void. The House of Lords apprehended on the view that there was no provision in the legislation that clearly defined whether the stock holder ought to remain autonomous of the majority of the stock holder. They argued that the terms of formation of a company were clearly entrenched in law and, as such, judges had no role in reading into the statute limitations they considered expedient (Duhaime, 2010). Lifting the Corporate Veil This expression simply denotes the departure that exists between a company’s ownership and its management. In addition, it also refers to the separation that occurs between a company’s officers and the company’s owners. A fundamental aspect of this is that the corporate should be preserved, and the corporate veil accorded the utmost respect it deserves (Tan, 1999). In essence, it can be said that the law operates to give protection to directors and shareholders from the company’s liabilities that it may have accumulated in the outside world. Since its inception, the lodestar of the company law is effectively treated as the integrity of the separate personality of the company. As such, the lifting of the corporate veil can only take place under very critical circumstances. However, the outcome of such lifting is the absence of clarity in the ultimate legal rights of the shareholders and the inter-action of the directors appointed to the board (Tan, 1999). Benefits of Salomon’s Principle There are quite a number of benefits accrued from the Saloman’s principle. One of such benefit is efficiency. Before the inception of the enactment of the principle, a business usually organised as a partnership could engage in a very tedious while creating contracts. This was as a result of the need to engage every partner to agree with the contract and also to involve the hidden nature of the rights and obligations of independent partners. With the Saloman’s principle that recognises the company as a discrete legal entity, it became easier to form contracts. Consequently, a company can easily create a contract in its name and hence making the process of contract creation for businesses relatively easy (Graham, 1998). Following Saloman’s principle, partners are at liberty to create a single contract although this has to involve a human being who was authorised to oversee the process of contract creation on the company’s behalf. In practice, it is often the case that for large contracts, people are usually given the mandate to initiate and create contracts. Thus, first people must identify the company’s article of association or accepted following a decree of the people appointed to the company’s board. In a nutshell, therefore, the corporate personality of companies ensures simplicity of trade in instances that require engagement with complex commercial organizations (Tan, 1999). Another benefit of this principle is in relation to the human beings that form part of the company’s internal organization. The principle serves to safeguard the interests of an entrepreneur, for instance, Aaron Salomon and thus reduces his risks in the event that the business fails. Usually, if an entrepreneur dealt as a sole trader, then in the event that a business fails, the trader would risk losing all of his investment (money, car, house and so on). However, by the entrepreneur organizing his business as a company, the entrepreneur effectively distinguishes his personal property from that of the company. Thus, only the property belonging to the company will be lost in the event that the business closes down (Googey, 1995). Issues with Salomon’s Principle Salomon’s principle has its share of flaws, as well, but the main one revolves around ethics. As discussed above, one of the benefits of the principle is allowing an entrepreneur to operate outside the organization so that their property is not affected in case the company undergoes insolvency. The consequence of this, for example, for a person in Aaron Salomon’s position would be that the person would be less concerned about the company’s affairs. In addition, the person may not be committed to deal honestly and fairly to third parties. This is because following the fact that he (entrepreneur) faces little or no personal loss in the likely event that the company collapses (Griffin, 1996). In a similar case, the company’s shareholders cannot be held personally responsible in the event that the business fails because the limited liability given by the company law explicitly limits their personal liability. Putting all these into consideration, one realises that the economy is run by companies whose shareholders and management that cannot be held responsible in the event that a company fails or undergoes a state of insolvency. The ethics of such an economy, therefore, remains questionable if no one faces the risk of open-ended, personal loss (Griffin, 1996). The Risks Faced By Shareholders and Entrepreneurs It is not absolute that in the event that a company fails the shareholders and entrepreneurs remain unaffected. These people are pretentious in innumerable ways. For example, the entrepreneurs will lose reputation from investors and other traders. The only thing that will not be affected will be his personal property. There are also criminal liabilities that can be instigated as a result of fraudulent and wrongful trading, and these will most likely affect the human being. In such a case, the company cannot provide cover for any criminal activity or any deliberate move to defraud its third parties (Gower, 2008). The Rationale of the Verdict on Company Law The conclusion made by the House of Lords regarding Salomon v Salomon & Co Ltd is highly important in the face of the modern company law (Puig, 2000). Given that the company’s existence is purely on its right, it means that any changes in its membership will do little as far as its existence as an entity is concerned. The decision taken at Salomon’s case also meant that members of company are at liberty to transfer their shares (Puig, 2000). Moreover, members of a company can even be declared insane or bankrupt, but that will not affect the company in any way (Gower, 2008). The recognition of a separate corporate persona doctrine vindicates the modern company contractual capacity in its right and, as such, the company can sue or be sued in its name. Also, this principle gives the company the right to own a business property as its own. The company’s members are only entitled to their shares but not the individual assets of the company (Gower, 2008). The modern corporate structure was informed largely following the need to provide entrepreneurs with fewer risks while making their investments and projects. The concept of limited liability, as entrenched in Salomon’s principle, dictates that a company’s shareholders’ liability cannot exceed the value of shares they own in the company. This is an important doctrine that justifies that the corporate is merely a means through which business is done and without the existence of a separate persona it could not exist. Salmon’s principle enables one to understand that a company, just like any other person in the society, is a separate person and that it is responsible for its debts (Tan, 1999). The Impact of the Decision on Company Law The most disturbing and intriguing question on the modern nature of the company revolves around the traits it carries. One wonders just how the modern company came to acquire the traits of distinct legal personality that it so much enjoys. The answer to this, however, can be found in the decision of the House of Lords in Salmon that categorically gave companies such distinct personality. To a large extent, the decision is correct under the circumstances. While everyone who reads the decision will be convinced that it is right, one wonders just why the members of the House of Lords were so certain that they made the right decision. For one, when following through these lordships’ speeches, one fails to find even a little reference to any pre-existing case law let alone any contemporary ideas or sources. Logically, one would expect a reference to at least the case involving Smith verses Anderson in which the court of appeal determined that the company remained a species of trust. Consequently, one could expect that the lordships could engage in a clearer discussion as to the underlying causes of the reversal in judicial policy. Looking at the decision from another perspective (from any of the judges in the Saloman litigation) one would say the company is more like the personality of Saloman and not at all a distinct person. This impression that companies are like masks behind which real people conduct their normal activities has its origins in the common law. Back in 1684, Lord Pollexfen C.J made a decision in which he was critical of the joint stock company. His Lordship’s view of the joint stock company was that it was like an invisible merchant whose whereabouts are difficult to tell. Moreover, it is that which in the judgement of law lacks both soul and conscience and yet forsooth are traders. Between the 17th and 19th Century, there occurred a benevolent judicial re-evaluation of the company’s allure. In most cases, companies were highly valued even to the extent of being equated to people (Graham, 1998). As such, companies were elevated to occupy a life world of their own out with the life worlds of the members, employees and creditors among other stakeholders. Saloman’s decision was pegged on the logic that was created upon the ideology of the company as a sentient, if artificial, the economic actor. Salomon’s Legacy Today It is a fact that that both the company and the individual hold different moral positions. Therefore, assigning dishonour to the company following its activities may not essentially decipher directly into dishonour conferring to any person. Although there is a general recognition by the English law that companies are likely to commit crimes, this does not directly connect stigma for criminal activities to the different stakeholders of the company (employees and shareholders just to mention a few). The company effectively shields individuals and thereby allows them to act behind the façade of corporate personality. In addition to the legal persons the companies had since 1897, they have a personality aspect now which incorporates image and reputation (Googey, 1995). The decision that ensued following Salomon’s case has been entrenched in today’s companies and is a tool to market themselves to other people, real and virtual. In conclusion, Salomon’s case verses Salomon & Co Ltd remains highly significant following its immense contribution to the development of UK’s company law. A lot of the conceptualization of the separate corporate personality comes from the jurisprudence shaped in Salomon., Thus, it is even one of the reasons that the distinct corporate persona is called ‘Salomon principle’ in the modern era. References Chen-Han, Tan (1999) “Piercing the Separate Personality of the Company: A matter of Policy,” J.Legal Stud. 49(3): 531-552 Davis Gower (2008) Principles of Modern Law, 8th edition. London: Sweet & Maxwell Griffin S (1996) Company Law Fundamental Principles, 2nd edition. London: Financial Times Pitman John Googey, (1995) Corporations and Associations Law: Principles and Issues, 3rd edition. Sydney: Butterworths Lloyd, Duhaime (2010) “1897, the Saloman Case: Judicial Life Breathed Into Corporations,” [Online] Available at http://www.duhaime.org/LegalResources/ConsumerCommercial/LawArticle-1197/1897-the-Salomon-Case-Judicial-Life-Breathed-Into-Corporations.aspx Rose Graham (1998) Corporate Personality in the 20th Century. New York, NY: Hart Publications Read More