Salomon vs A Salomon & Co Ltd [1897] AC 22 is one of the most famous corporate case in history. The case highlighted the very basic principle of the separation of a company from its shareholders and directors.
Background
Aron Salomon was a boot maker and had run the successful business for 30 years as a sole trader. In a point of time, he decided to give five of his sons the shares of the business. To make it official, he turned the business into a company under the English Companies Act. The total shares were 20,007 worth £1 each. Instead of issuing them to the public, Salomon took 20,001 of the shares and gave the rest to his wife and sons, each of them received a share. Salomon and his two eldest sons were then appointed as directors of the company.
The total worth of the company was £39,000, consisting of shares worth £20,000 and debentures worth £10,000 which were issued to Salomon; £1,000 cash and £8,000 unsecured debts. The court noted that the value was excessively overestimated.
Financial Difficulty and Liquidation
After a while, the company was teetering as a result of strikes in the industry. Salomon injected more funds, which were apparently not sufficient to put it in stability. He then borrowed £5,000 from Edmund Broderip by reissuing the debentures in Broderip’s name.
The injection of funds was proven insufficient, and the business deteriorated further. Broderip appointed a receiver to realise his security, and when the company default, the liquidator was appointed.
The liquidator found that the company’s assets were worth only £6,000. £5,000 was used to repay Broderip’s claim, and the remaining £1,000 went into Salomon’s account as a beneficial owner of the debentures. If these were granted, there would have been nothing left to repay £8,000 to the unsecured creditors.
The liquidator counterclaimed Broderip’s claim by stating that the debentures were invalid. The liquidator also stated that the formation of the company was a fraud by deceiving the unsecured creditors with the excessive price of the business.
Hearing and Decision
The House of Lords unanimously decided in Salomon’s favour. It was in accordance with Companies Act 1862 (UK) that a trader has limited liability and obtains priority as a debenture-holder over other creditors. A person may sell his business to a limited liability company of which he/she is the only shareholders and directors. It followed that the company was a separate legal entity distinct from its shareholders and directors. Also, the company could be a secured debtor of its shareholders, thereby enabling them to rank ahead of its unsecured creditors.
The House of Lords also stated that the fact that Salomon owned 20,001 of the total 20,007 made no difference. A separate entity is created following the incorporation, even if all the company’s shares are owned by a single person.
Source:
- Wikipedia, www.wikipedia.com;
- Additional Reading of Companies and Securities Law, Faculty of Business, University of Technology, Sydney.