Salomon v. Salomon & Co., Ltd. (1897)

This is the foundation of the whole subject. Every proposition in Module 1 — perpetual succession, the company's own property, its own contracts, its own debts, the limited liability of its members — is a consequence of the single holding here: that a company duly registered is a person in law distinct from the people who own it, and that the motive for forming it is irrelevant.

It matters equally for the way it was decided. Two courts below had held that the company was a myth, a sham, a mere alias for Aron Salomon, and had made him indemnify it. The House of Lords reversed them on a point of method: a court may not read into a statute a limitation Parliament did not write. That is why the case is quoted as much for its approach to construction as for its result.

Aron Salomon had for some thirty years before 1892 carried on business on his own account as a leather merchant and hide factor, and as a wholesale and export boot manufacturer, under the style of A. Salomon & Co. The business had been prosperous, yielding annual profits sufficient to maintain his family and add to his capital, and it was perfectly solvent at the date of the transfer.

In July 1892 he entered into a preliminary agreement with one Adolph Anholt, as trustee for a company not yet formed, settling the terms on which the business would be transferred; one condition was that Salomon would receive £10,000 in debentures of the company as part payment. A memorandum of association was then executed by Salomon, his wife, a daughter and his four sons, each subscribing for one share, and was registered on 28 July 1892. The company, Aron Salomon & Co., Ltd., had a nominal capital of £40,000 divided into 40,000 shares of £1 each.

The company adopted the agreement, and within a month or two the parties had performed it. Salomon received 100 debentures of £100 each, on the security of which he obtained an advance of £5,000 from Edmund Broderip. In February 1893 the original debentures were returned and cancelled, and fresh debentures of the same amount were issued directly to Broderip to secure his loan with interest at 8 per cent. In September 1892 Salomon applied for and obtained an allotment of 20,000 shares, so that the register stood at 20,001 shares held by Salomon and six shares held by his wife and family, and so remained.

The price paid by the company for the business was £38,782. Of that, £16,000 was to be paid in cash or debentures; the first board — Salomon and two of his sons — resolved to pay £6,000 in cash and £10,000 in debentures. The liquidator later alleged that the price exceeded the real value by upwards of £8,200.

The business failed. Emanuel Salomon, a son who had worked in it for nearly twenty years, attributed the failure to a succession of strikes in the boot trade, and there was no evidence to the contrary. Broderip's interest fell into arrear; he sued to enforce his security; a compulsory liquidation order was made in October 1893 at the instance of unsecured creditors. On the figures, if the assets went first to Broderip there would remain a balance of about £1,055, claimed by Salomon as beneficial owner of the debentures, and nothing at all for the unsecured creditors, whose debts amounted to over £7,000.

The liquidator, in the company's name, counterclaimed for rescission of the two agreements, delivery up and cancellation of the debentures, repayment of everything paid to Salomon, and a lien. The pleaded grounds were that the price was excessive, that the formation of the company was a fraud on the creditors of the company, and that no independent board had ever been appointed. No evidence was led to support the allegation about the board.

Vaughan Williams J refused that relief but suggested another route, and allowed an amendment. The amended claim was that Salomon must indemnify the company against the whole of its unsecured debts, and it was accompanied by averments that the company was formed and the debentures issued so that he might take all the profits without risk, and that the company was the mere nominee and agent of Salomon. On rehearing, the judge gave the company its decree of indemnity.

The Court of Appeal affirmed. Its order recorded its opinion that the formation of the company, the agreement and the issue of debentures were "a mere scheme to enable him 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 further to enable him to obtain a preference over other creditors by a first charge on the assets. Lindley LJ, while accepting "that the incorporation of the company cannot be disputed", said that "the object of the whole arrangement is to do the very thing which the legislature intended not to be done", and added that "Mr. Salomon's scheme is a device to defraud creditors."

Three distinct theories were therefore run below, and you should keep them apart — the agency theory (the company was Salomon's agent, so he must indemnify it), the trustee or dummy theory (the other six were nominees, so there were not really seven members), and the fraud on creditors theory.

1. Was the company validly constituted, seven persons having in form subscribed?
2. If it was, does it follow that it is a legal person distinct from Salomon, notwithstanding that he holds all but six of its shares and controls it entirely?
3. Are the motives of those who formed the company relevant to their rights and liabilities?
4. Was the sale, or the issue of debentures, liable to be set aside on the Erlanger principle?

The appeal was allowed. Salomon was not liable to indemnify the company, and his debentures stood.

Lord Halsbury LC — the method

The important question, he said, was whether the company was a company at all — whether that artificial creation of the legislature had been validly constituted — and to answer it one must look at what the statute itself has determined. "I have no right to add to the requirements of the statute, nor to take from the requirements thus enacted. The sole guide must be the statute itself."

Seven actual living persons held shares. The statute "enacts nothing as to the extent or degree of interest" which may be held by each of the seven, or as to the proportion of interest or influence possessed by one or by the majority over the others. One share is enough. Nor is the motive of becoming, or of making others, shareholders a permissible field of inquiry.

He conceded one exception: if it could be established that the statutory requirement had not been complied with, one could go behind the certificate of incorporation to show that a fraud had been practised on the officer who granted it. Short of such proof, once the company is legally incorporated "it must be treated like any other independent person with rights and liabilities appropriate to itself".

The killing blow is aimed at the agency theory. Vaughan Williams J had held that the business was Salomon's and that he chose to employ a limited company as agent. Lord Halsbury exposed the contradiction: "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". You cannot say at the same time that there is a company and there is not.

He then pressed the Court of Appeal's reasoning to destruction. Where in the statute is the supposed intention of the legislature manifested? If the prohibition is not merely that the seven must not be members of one family, how far may influence, or the intentional purchase of a majority, be carried before it offends? May two or three of the seven hold the whole? Must each have an independent beneficial interest? "If the legislature intended to prohibit something, you ought to know what that something is."

Lord Watson — the facts, and the Erlanger point

Lord Watson set out the history and made three findings of fact that answer the fraud allegation. The business was sound and solvent when transferred; the liquidator himself admitted so in cross-examination. There was no evidence that no board was appointed or that the board consisted only of Salomon. And all the members were fully cognisant of the terms of the agreements and accepted them.

On the original claim for rescission he agreed with Vaughan Williams J that where you have a private company and all the shareholders are perfectly cognisant of the conditions of formation and of the purchase, "you can possibly say that purchasing at an exorbitant price" — and the judge had no doubt that the price was exorbitant — is "a fraud upon those shareholders or upon the company"; the answer is that you cannot.

Why Erlanger did not apply. In Erlanger v. New Sombrero Phosphate Co. the vendor had got up the company in order to sell his adventure to it, attracted shareholders by a prospectus that was essentially false, and sold to directors who were virtually his nominees and did not know the real facts, the shareholders sanctioning the transaction on the directors' assurance. Here, by contrast, the agreement was approved and adopted "in the full knowledge of the facts" by the company itself and by all the shareholders who ever were or were likely to be members. There was no one left to be deceived.

A company duly registered under the Act is, from the date of incorporation, a legal person distinct from its members, with rights and liabilities of its own; and neither the concentration of its shares in one hand nor the motive with which it was formed alters that. A court may go behind the certificate of incorporation only to show that the statutory conditions were not satisfied and that a fraud was practised on the Registrar.

Two corollaries follow, and both are examinable in their own right. First, a controlling shareholder may be a secured creditor of his own company, and his security binds the unsecured creditors — which is precisely the outcome the courts below found intolerable. Second, a sale by a promoter to a company is not fraudulent merely because the price is excessive, if every member knows the facts and assents; disclosure to those entitled to receive it cures what would otherwise be a breach.

The judgment is best understood as a choice between two ways of reading a companies statute. The Court of Appeal read the Act purposively: incorporation was granted so that several people could combine capital, and a one-man company defeats that purpose. The House of Lords read it literally: the Act stated its conditions, they were met, and the consequence the Act attaches to registration follows.

Lord Halsbury's argument is that the purposive reading has no stopping point that a court could state. Every candidate limitation — that the seven be unrelated, that each hold a substantial interest, that none control the rest — is a rule a judge would have to invent, and none of them is in the statute. A prohibition nobody can formulate is not a prohibition.

The practical consequence was accepted with open eyes: unsecured creditors of a company may find that the controller ranks ahead of them by his own charge. Parliament's answer, then and since, has been disclosure and registration rather than the denial of personality — which is why the modern Act meets the Salomon problem with the registration of charges, the prospectus and disclosure regime, and the specific statutory lifts of the veil, rather than by qualifying s. 9.

The principle is stated by the Supreme Court in Subhra Mukherjee v. Bharat Coking Coal Ltd. as "the foundation of joint stock company and a basic incidence of incorporation both under English law and Indian law", and in the same breath the Court records that lifting the veil "under statutes and decisions of the courts is an equally settled position of law". Under the Companies Act 2013, s. 9 supplies the separate personality, s. 4(1)(d) the limited liability, and ss. 7(6) and 7(7) the clearest statutory lifting: where a company is got incorporated by false information the promoters, first directors and the certifying professional face action under s. 447, and the Tribunal may direct that the liability of the members be unlimited — the modern, statutory version of Lord Halsbury's exception for fraud on the Registrar.