Salomon vs Salomon & Co Ltd - Case Study Example

The landmark and widely recited case of Salomon v Salomon & Co Ltd1 needs no detailed explanation; suffice it to say that from it was borne the concept of corporate personality. Mr. Salomon’s circumstances indeed inspired such aptly phrased statements as ‘the company is ex hypothesi a distinct legal persona’2 and ‘the company is at law a different person altogether from the subscribers to the memorandum…nor are the members as subscribers liable…except to the extent and in the manner provided by the Act.’3 From the decision of Salomon flowed several consequences, and clarified became the scope and appropriate use of the Companies Act 1862. Fundamentally, the House of Lords thus embedded the separation of the corporate personality from its members and it became its own entity, rendering it capable of suing and being sued; of entering into contracts;4 of owning property and of making profits and losses in its own name.5 The final element established was the widely famous advantages of limited liability enjoyed by shareholders, limited only to the unpaid amount of their shares. These principles have been referred to a reused in countless cases; Lord Templeman himself described the dicta in Salomon as an ‘unyielding rock’6 and it is now embodied in the Companies Act 2006.7 As is the case with most fundamental principles following a single landmark case, a broad debate has been alive since the decision. Indeed, the courts have been faced with circumstances in which exceptions to Salomon have been necessary and indeed allowed. Thus, one is faced with a fundamental principle, deemed to apply broadly, yet inevitably the court has managed to manoeuvre around the Solomon rules in order to make it more flexible. But is this really flexibility, or an undesired and confusing method of applying the rules simply whenever the court deems fit or not? This topic is linked to clarity – if one can arrive at a clear set of circumstances under which the corporate veil will not be lifted, then one can arrive at the conclusion that the Salomon decision is safely applicable. If these circumstances are not evident, then it seems that the courts apply it or not at whim, and the Salomon case is at the mercy of the court and its view of whether the veil should be lifted in the particular circumstances or not. The specifics of these circumstances are affected by the two different views surrounding the consequences of separate legal personality. The narrow view - as that contained in the Companies Acts - holds that a company’s rights, property and liabilities belong to the company only. The wider view argues that persons are prevented from having any effect on or being considered in relation to a company’s legal rights and obligations. Indeed, the law acknowledges that exceptions exist, as is always necessary, and both common law and statutory exceptions serve to treat ‘the rights or liabilities or activities of a company as the rights or liabilities or activities of its shareholders.’8 The statutory exceptions to corporate personality appear to be difficult to apply; the Salomon principle is a fundamental one and is not to be easily set aside. In a way, one could view the situation as a safely protected set of principles created by the Salomon decision, digressions from which are only absolutely necessary, and thus keep in tune with the decision. Lord Diplock indeed acknowledged the statutory basis of the corporate veil and stressed that ‘any Parliamentary intention to pierce the corporate veil would be expressed in clear and unequivocal language’ though the absence of such language could still allow for the piercing of the veil in special circumstances through a ‘purposive construction’ of Parliament’s intention.9 Though, as Tunstall v Steigmann10 stressed, it is important to remember that the ‘purposive construction’ must be clear; it is not easily implied. Various other statutory provisions serve to lift the veil in specific circumstances, include those such as taxation within group structures. It has been suggested that such provisions do not exactly serve to lift the veil per se; rather they impose extra obligations on subsidiaries, thus emerges the ‘piercing’ of the veil as opposed to the ‘lifting’ of the veil. Fraud also serves as a more definitive potential for the lifting of the veil, understandably. The Insolvency Act 1986 may assign personal liability to directors or shareholders if it appears that the business was conducted for any fraudulent purpose11 or if there is evidence of director’s misconduct12 or if the directors were negligent by not winding up the company if it had no reasonable prospect of surviving.13 This has the potential to be broadly interpreted, but is arguably necessary in such circumstances. One must bring to attention the potential of company members to intensely abuse the corporate veil, and the court has recognised the need to reduce this possibility and thus temptation as far as is possible. It is adequate to state that the case law on lifting the veil is somewhat sporadic in nature and gives no clear principles as to when the veil will or will not be lifted. But can it give those clear principles? This issue is further explored below. The timeline of cases does depict the rather extreme fluctuation of the courts’ approach over the years. Circumstances in which courts have lifted the veil include where the company is a façade, where fraud has been committed, where groups of companies are formed and where an agency exists. It is somewhat important to explore each circumstance in order to assess just when the veil is deemed to be fragile enough to lift, to arrive at a stronger conclusion as to whether these exceptions serve to strengthen or weaken the Solomon decision. Under the façade exception, the court in Merchandise Transport v British Transport Commission (No.1)14 refused the separation of corporate personality where it was shown that the subsidiary company had been created as a device to avoid formalities when obtaining a favourable licence. Additionally, a façade has been found when a company has been created to avoid an employment covenant, as was the case in Creasey v Breachwood Motors Ltd, which held that the directors had deliberately ignored the separate legal personalities of the two companies when transferring assets between them.15 However, Creasey was overruled by Ord v Bellhaven Pubs Ltd on the basis that a reorganisation of the company group is legitimate, where the reorganisation appears to be in good faith. It is clear to see that the reason the veil is lifted in these circumstances is because the company is suspected to have been created in order to evade some kind of legal obligation – the courts find it necessary to lift the veil and thus enforce the obligation. One can see an emerging attempt to balance the sacred concept created by Salomon and abuses of that very concept. Some kind of dishonesty is required; mere unconscionable conduct is not enough, or as Russell J dramatically describes the company to be ‘a device and a sham, a mask which he [the defendant] holds before his face in an attempt to avoid recognition by the eye of equity.’16 Group-structure companies are often formed as a way of avoiding obligations, liabilities, tax and regulations. Wholly owned subsidiaries are created by the parent company, who is thus a shareholder with limited liability should the subsidiary fall into trouble. Courts are often suspicious of group companies due to the fact that the lines often blur between the groups in many aspects. Lord Denning primarily held that a group of companies are a single entity and should be treated as such.17 However, Lord Roskill disagreed, stating that each company in a group ‘is a separate legal entity possessed of separate legal rights and liabilities so that the rights of one company in a group cannot be exercised by another company in that group.’18 Similarly, the House of Lords in Woolfson v Strathclyde Regional Council19 rejected Denning’s dicta and held that the veil would only be lifted if the group was a façade. However, the Court of Appeal later favoured Denning, stating that the veil may be lifted ‘if it is necessary to achieve justice irrespective of the legal efficacy of the corporate structure under consideration.’20 Of course, this concept is rather uncertain and thus open to the potential weakening of the security the incorporation seeks to achieve. Subsequently, the judge in Adams v Cape Industries21 criticised the Court of Appeal in Re a Company and narrowed its scope on the basis that the law should recognise the operation of subsidiary companies. The lifting of the veil was restricted to special circumstances in which the court is interpreting a statute or legal document; where a mere façade is indicated;22 or where an express or implied agency agreement is evident. The court also distinguished between moral approval and actual legality, stressing the irrelevance of the former. If an agency relationship exists, then it follows that the principal is responsible for the actions of the agent within the agency scope. Thus, in the present context, if a holding company is found to be the agent of the subsidiary company, the veil is justifiably lifted. It is important to state that the courts’ eagerness to find an agency is not overwhelming – some would even call it reluctant. The agency must be an express agreement although the courts have stressed that it is a question of fact, in which agency can be inferred from the surrounding circumstances.23 Again, Salomon establishes that mere membership of a company will not serve to make it an agent. Similarly, agency cannot be inferred from its members’ exercisable control over it24 and, of course an agency will not be found if the members did not consent to its creation.25 So exactly how is an agency formed? The main characteristic of an agency is that the agent has the authority to create relations of a legal manner between the principal and third parties. However, it must be stressed that the general finding of agency within the veil lifting sector is rare because a business is normally intended to belong to the business, and not a member’s business. It is rather clear that there is no general principle in case law as to when the veil will be lifted. Forgive the bluntness of the assessment that the courts will uphold Salomon, and the courts will not uphold Salomon. There are no precise or indeed satisfactory explanations to predict with certainty when the veil is likely to be lifted and under which circumstances. Although situations in which the veil has been lifted can be confined to criteria of circumstances, the courts have also refused to lift the veil in the same circumstances. It seems that the courts merely try to maintain a balance between the Salomon principle and the provision of justice, and leave themselves open to rule depending on the circumstances of the particular case. It is to be remembered the strength with which the Salomon principle burst onto the company law scene all those years ago; it is at least close to say that exceptions are rare and stringently decided, and more commonly activated under statutory authority. This arguably keeps safe the Salomon principle, and the very fact that it has been made more flexible to thus apply to all circumstances means that it is more likely to uphold justice. As is always the case, a fundamental principle cannot be applied ‘as is’ to every case, and one would be mistaken if one were to think that creating exceptions to it would strengthen its very existence. One must not forget the overall existence of such a fundamental principle; to uphold the course of justice, and if to do so require that an exception be made to it, then it should be, and indeed it is strong enough to be overlooked yet still be an applicable decision. One must thus ask - should we need a clear principle here, and would this make the Solomon decision strong? To diverge from a decision such as this is not necessarily to weaken it. One must keep in mind the immense diverse nature of company law – can one principle really cover it all? It seems that flexibility has been favoured over predictability, and why not so? The whole reason for the existence of the courts’ ability to lift the veil is to prevent the abuse of the corporate personality. The primary intention of the Solomon principle was so prevent such abuse and if exceptions to it must be made in order to uphold this primary intention, then it is nothing but more reinforced by these exceptions which enable it to apply to such a wide variety of circumstances and still hold strong. BIBLIOGRAPHY Abolish Veil Piercing, Stephen M. Bainbridge; UCLA School of Law. 2000 http://papers.ssrn.com/paper.taf?abstract_id=236967 Cases & Materials on Company Law, Andrew Hicks & S.H. Goo; 5th edition. 2004 Oxford University Press: NY. Collapsing Corporate Structures: Resolving The Tension Between Form and Substance, Steven L. Schwarcz. Duke Law School Public Law Research, Paper No. 41; 2003. Company Law, Alan Dignam & John Lowry; 4th edition. 2006 Oxford University Press: NY. Company Law, Brenda Hannigan; 2003 Oxford University Press: NY. Lifting The Corporate Veil on the Basis of an Implied Agency, Jason Harris, Company and Securities Law Journal, Vol. 23; 2005 Revamping Veil Piercing for All Limited Liability Entities: Forcing the Common Law Doctrine into the Statutory Age, Rebecca J. Huss: 70 U. Cin. Law Review 136; 2001. Collapsing Corporate Structures: Resolving the Tension Between Form & Substance, Steven L. Schwarcz; 2003. Smith and Keenan’s Company Law, 14th Edition, Charles Wild and Stuart Weinstein. Pearson Education; 2009. Read More