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Salomon v/s Salomon: In 2022

Salomon was a leather merchant and trader who decided to incorporate a company and convert his business to the incorporated company. In payment of purchase money to Salomon, debentures which had a floating charge on it worth 10,000 were issued to him. Additionally, 20,007 shares were issued by the company in which 20,001 shares were allotted to Salomon and the remaining 6 shares were allotted to his family: wife, daughter and four sons, one share each.

By virtue of being a majority shareholder, Salomon gained the power to outvote the other shareholders, thus assumed absolute control over the company and was appointed as managing director. The company, after incorporation, acquired debts and loans of 7,000 from unsecured creditors. The company was not performing well and therefore Salomon sold his debentures to one Mr. Edmund in 5,000. The 5,000 received by Salomon was then loaned to the company at a 10% interest rate.

After one year, the company went into liquidation with total assets of 6000, out of which, 5,000 was given to Mr. Edmund as repayment of debentures by virtue of him being a secured creditor. Salomon being the other secured creditor was under the impression of taking a precedence for the remaining 1,000 over the unsecured creditors thus leaving them with nothing.

A suit was filed and the issue in front of the court was whether Salomon would be personally liable to repay the creditors being the controller of the company. The case, on appeal, went to the House of Lords where it was established that a company is a separate legal entity. Since, the company took debts from these creditors, Salomon being merely an agent of the company cannot be held personally liable for any debts incurred by the company.

It was observed by the Lords that Salomon followed the essentials to establish a company as per the Companies Act, 1862, to the teeth. The company of Salomon was therefore held to be legitimate and the Lords dismissed any claims relating to the fraudulent nature of the company thus not lifting the corporate veil.

Holding of the case in 2022
After the famous case of Salomon which laid down the principle of separate legal entity of a company, the said principle witnessed ground-breaking changes along with the doctrine of corporate veil and evolved through time. In 2022, Salomon's case is considered to have been an error of judgement and if it were to be decided today, the holding of the case would differ substantially.

Held: The case of Salomon is of a kind where the line between a company and its shareholders gets blurred. Being a majority shareholder, Salomon was in complete control over the workings of the company.

The court in Gilford Motor Company Ltd. v. Horne[1] pierced the corporate veil for the purposes of the company being a mere sham and acting fraudulently. Correspondingly, the case of Woolfson v. Strathclyde Regional Council[2] it is effectively analysed that a company has a separate legal personality different from its shareholders and directors, but when it is engaged in a dishonest or fraudulent activity, such separate personality ceases to exist and the fraudulent activity conducted under the cloak of company's separate entity becomes attributable to the members of the company.

Salomon's company had a total of 20,007 shares and further shares were never issued. Out of the 20,007 shares, 20,001 shares were held by Salomon himself making him the majority shareholder and giving him outvoting rights. It is interesting to view that the remaining 6 shares of the company were held by Salomon's family members. The respondent's argument that the company never had an independent existence[3] is validly accepted.

Salomon was the sole promoter, managing director, and the majority shareholder who took major decisions of the company and was in complete control over the activities of the company. The six other shareholders can be distinguished as mere puppets of Salomon who were used to fulfil the bare minimum essentials required in the Companies Act. It has been ascertained by the courts before, that the doctrine of corporate veil must be subject to certain exceptions and limitations.

In the case of Standard Chartered Bank v. Pakistan National Shipping Corporation[4], it was reasoned that any fraudulent activity is a ground for lifting corporate veil. Furthermore, it is also viewed that when the agency of the company shifts to its members, thus making the company as an agent of its members, the directors and shareholders become potentially liable in such cases[5]. In the present case, the motive of Salomon to incorporate a limited liability company can associated to merely reducing his losses and transferring them to his creditors.

uch a conclusion has been drawn from the reasonings that the minority shareholders were family members of Salomon thus giving Salomon undisputed position in company and making him the sole decision maker. When the company started to incur a series of losses, Salomon acquired loans from unsecured creditors cunningly thinking that he by being a secured creditor would take the assets of the company if something were to go sideways.

The entire profit margin of the company went into the pockets of Salomon; thus, it is deemed that the incorporation of the company was to benefit Salomon entirely and to defraud the creditors. As established, any fraud in the name of the company is potentially associated with the directors of the company and therefore the corporate veil must be lifted.

Furthermore, being in complete control of the company and its activities, profits or losses, Salomon was not acting as an agent of the company but vice versa. The company was a mere sham which was under Salomon's discretion and all his activities cannot be concealed under the name of the company. The essence of the Companies Act was not fulfilled while incorporation but rather the terms were fulfilled as a mere requirement ignoring the essence of the law.

Salomon himself acquired purchase money in the form of debentures and valued the company making it suspicious with respect to his motives while incorporating the company. Therefore, it is validly construed that Salomon intended to defraud the creditors and shelf off the losses by making himself a debenture holder and incorporating the company. He cannot therefore hide behind a sham company and the corporate veil must be pierced for equity and good conscience to prevail.

Comparative Analysis and Conclusion
The principle of a company having a legal entity separate from its members essentially distinguishes it, its assets, and liabilities from that of the directors and shareholders of the company. This legal principle has perpetually evolved from the phase of Salomon's case to limiting it to certain exceptions.

The court has analysed the independence, and rights and liabilities of a company in a liberal way but has constrained it wherever it deems necessary on a case by case scenario. From 1896 when the House of Lords did not lift corporate veil in Salomon's case rigidly applying the letter of the law, the courts have moved to an understanding of establishing the essence of law that is deemed pertinent. Piercing of corporate veil is an exercise adopted by the court to further public good and to avoid any fraud.

Indian courts in such an exercise has based its decisions on two theories namely, theory of alter ego wherein it is viewed that the lines between a company and members are blurred and the company acts as a mere alter ego of the members[6]. In cases such as Salomon's where the company was practically an alter ego of Salomon, 2022 laws permit the lifting of corporate veil to meet the ends of justice as against what House of Lords opined in 1896. The second theory is the instrumentality theory wherein the court views that whether the directors of the company use company to benefit themselves or the company at large[7].

Salomon assessing the value of the company himself and acquiring debentures based on that assessed value and shifting the losses to unsecured creditors makes it questionable whether his motives were indeed the betterment of the company or just benefitting himself and securing profits for himself. In 1896, the court did not look into the angle of instrumentality but was rather fixated on the fact that the creditors cannot be validly held to be defrauded and the company is legal entity on its own. Shareholders who were then called to be irrelevant[8] to the matter may hold great relevance today to prove that the company was merely an agent of Salomon and a sham company.

For years Salomon v. Salomon was upheld as a landmark judgement and many high profile cases like Macaura v. Northern Insurance Company[9] were decided on the principles laid down in Salomon's case.[10] More than a century has passed by since House of Lords delivered this landmark judgement, the laws have evolved to a great degree and the interpretation of courts with respect to laws and cases has also evolved. Therefore, if the case of Salomon was brought into court today, it is safe to assume that the decision and ratio might have been different from what the court delivered 126 years before.

End-Notes:
  1. (1933) Ch 935
  2. 1978 S.C. 2 (HL) 90
  3. Salomon v. Salomon, [1896] 11 WLUK 76
  4. [2003] 1 B.C.L.C. 244
  5. Zoher Shabir, 'Limited Liability A history of Salomon v Salomon' (2021) https://ai-law.co.uk/limited-liability-a-history-of-salomon-v-salomon/ date accessed 29th October 2022
  6. Kunal Bhardwaj and Tharun Chowdhary, 'Pardey ke Peechey kya hai- A Comprehensive Analysis of the Evolution of the Corporate Veil Doctrine in India' [2022] Manupatra Articles https://articles.manupatra.com/article-details/Pardey-ke-Peechey-kya-hai-A-Comprehensive-Analysis-of-the-Evolution-of-the-Corporate-Veil-Doctrine-in-India date accessed 29th October 2022
  7. Id.
  8. Supra 3
  9. (1925) AC 619
  10. Supra 5

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