Salomon v. Salomon and Co. Ltd (1897)

Section 3(1) of the LLP Act says that a limited liability partnership is a body corporate formed and incorporated under this Act and is a legal entity separate from that of its partners. Section 3(2) gives it perpetual succession, and s. 3(3) provides that a change in the partners does not affect its existence, rights or liabilities. Section 14 then gives it the capacity to sue and be sued, to own and dispose of property, and to do and suffer such other acts and things as bodies corporate may lawfully do and suffer. Sections 27(3) and (4) and 28(1) complete the structure: an obligation of the LLP is solely the obligation of the LLP, its liabilities are met out of its property, and a partner is not personally liable for such an obligation solely by reason of being a partner.

Every one of those provisions rests on an idea that is not obvious and was fought over for five years in the English courts: that a body corporate is a person in law distinct from the human beings who compose it and control it, and that this is true even where the human beings are one family and one of them holds all but a handful of the shares. Salomon settled it. It is the reason a partner in an LLP is a stranger to the LLP's debts, and — through s. 66 — the reason a partner may lend money to his own LLP and be treated like anyone else.

Aron Salomon had for some thirty years before 1892 carried on business as a leather merchant and hide factor and wholesale and export boot manufacturer, on his own account, under the style of A. Salomon and Co.

With the design of transferring the business to a joint-stock company consisting exclusively of himself and members of his own family, he entered on 20 July 1892 into a preliminary agreement with a trustee for the future company, settling the terms of the transfer. One condition was that he was to receive £10,000 in debentures of the company in part payment.

A memorandum of association was then executed by the appellant, his wife, a daughter and his four sons, each subscribing for one share. It was registered on 28 July 1892, incorporating the company as Aron Salomon and Co. Ltd, with liability limited by shares.

The nominal capital was £40,000 in £1 shares. 20,007 shares were issued, of which the appellant held 20,001 and the other six signatories one each. The business was sold to the company for £38,782, of which £16,000 was to be paid in cash or debentures; at the first meeting of directors — the appellant and two of his sons — it was resolved to pay him £6,000 in cash and £10,000 in debentures. Those debentures were afterwards mortgaged by Salomon to one Edmund Broderip to secure an advance of £5,000; they were eventually cancelled and £10,000 of fresh debentures issued to Broderip.

In October 1893 an order was made for the winding up of the company. At that date the company was indebted to unsecured creditors other than Aron Salomon to the amount of £7,773. The liquidator sued Salomon.

Vaughan Williams J. declared that the company was entitled to be indemnified by the appellant. His reasoning was that the business was Salomon's business and no one else's, that he had chosen to employ a limited company as his agent, and that a principal must indemnify his agent. He proceeded mainly on the ground that the appellant was in truth the company, the other members being either his trustees or mere dummies, so that he carried on his own business under cover of the company's name, which was nothing more than an alias for Aron Salomon.

The Court of Appeal affirmed, on the ratio embodied in its order: that the formation of the company, the agreement and the issue of debentures were a mere scheme to enable Salomon to carry on business in the name of the company with limited liability, contrary to the intent and meaning of the Companies Act 1862, and to enable him to obtain a preference over other creditors by procuring a first charge on the company's assets. Lindley L.J., while observing that the incorporation of the company could not be disputed, said that the object of the whole arrangement was to do the very thing which the legislature intended not to be done, and that the scheme was a device to defraud creditors.

1. Was the company validly incorporated, and if so, was it a legal person distinct from Aron Salomon?
2. Could Salomon be made to indemnify the company against its unsecured creditors on the footing that the company was his agent?
3. Could the sale to the company, or the issue of debentures, be set aside as a fraud on the company or its creditors?

The appeal was allowed. Salomon was under no liability to the company or to its creditors, and his debentures were valid.

The contradiction in the agency argument

Lord Halsbury L.C. put the decisive point in a sentence a student should be able to reproduce. He assumed, for the sake of argument, the Court of Appeal's proposition that the formation of the company was a mere scheme to enable Salomon to carry on business in the company's name; and he said he was wholly unable to follow the proposition that this was contrary to the true intent and meaning of the Companies Act. The true intent and meaning of the Act can only be found from the Act itself, and the Act appears to give a company a legal existence with rights and liabilities of its own, whatever may have been the ideas or schemes of those who brought it into existence.

He then exposed the internal contradiction in the trial judge's agency reasoning. Either the limited company was a legal entity or it was not. If it was, the business belonged to it and not to Salomon; if it was not, there was no person and nothing to be an agent at all; and it is impossible to say at the same time that there is a company and there is not.

There is no prohibition in the statute to be found

The Court of Appeal had said the arrangement did the very thing the legislature intended not to be done. Lord Halsbury asked the obvious question: where is that intention of the legislature manifested in the statute? Even if the court were at liberty to insert words to manifest such an intention, it would have great difficulty in ascertaining what the intention was. In this case the members of one family held all the shares; but if the supposed prohibition is not limited to that narrow proposition, to what extent may influence, or authority, or the intentional purchase of a majority among the shareholders be carried before it falls within the supposed prohibition?

It is easy to say that something was contrary to the intention of the legislature — a proposition which, by reason of its generality, is difficult to test — but when one tries to state affirmatively what the legislature has prohibited, there is an insuperable difficulty in inserting such a prohibition into the statute by construction.

He tested the point further. May two or three, or indeed all seven, constitute the whole of the shareholders? Must they all be independent of each other, in the sense of each having an independent beneficial interest? That question cannot be answered by saying it is a matter of degree. If the legislature intended to prohibit something, you ought to know what that something is. All the statute had said was that one share is sufficient to constitute a shareholder, though the shares may be a hundred thousand in number; and there is nothing in the statute from which to derive a limitation that a shareholder must be independent and beneficially interested.

The claim to rescind failed too

Lord Watson dealt with the liquidator's original claim to have the sale agreement set aside. He agreed with Vaughan Williams J. that where you have a private company, and all the shareholders are perfectly cognisant of the conditions under which the company is formed and of the conditions of the purchase by the company, you cannot say that purchasing at an exorbitant price is a fraud on those shareholders or on the company. The authority relied on by the liquidator, in which a promoter had attracted shareholders by an essentially false prospectus and sold to directors who were his nominees and unaware of the real facts, had no application: here the agreement was in the full knowledge of the facts approved and adopted by the company itself, and by all the shareholders who ever were or were likely to be members.

A company duly incorporated under the Companies Act is a legal person distinct from its subscribers, with rights and liabilities of its own, whatever the motives of those who brought it into existence. It is not the agent or trustee of its controlling member merely because he holds almost all the shares, and its members are not liable for its debts beyond the statutory limit. A court may not read into the incorporation statute a prohibition on a company whose members are not independent of one another, since no such prohibition can be stated affirmatively from the words of the Act.

The three propositions that make Salomon the foundation of Module 2 are these.

Separate entity by force of the statute. Lord Halsbury found the entity in the Act itself. Section 3(1) does the same work for an LLP, in words that leave nothing to argument: a body corporate and a legal entity separate from that of its partners.

The consequence for creditors. Because the entity is separate, its obligations are its own. Sections 27(3) and (4) enact that; s. 28(1) protects the partner from personal liability solely by reason of being a partner; and s. 21(1) requires the LLP to put on its invoices and correspondence a statement that it is registered with limited liability — the public notice that is the price of the privilege.

The limits of the principle. Salomon protects the honest use of the form, not fraud. Lord Watson's treatment of rescission turned on the fact that everyone concerned knew the facts. The LLP Act draws the line expressly in s. 30: where an act is carried out by the LLP or any of its partners with intent to defraud creditors or for any fraudulent purpose, the liability of the LLP and of the partners who so acted becomes unlimited, with imprisonment up to two years and a fine, and compensation under s. 30(3). Section 28(2) makes the same point at the level of the individual partner: the shield does not cover his own wrongful act or omission.