ABSTRACT

The judicial pronouncement in the case of Salomon vs. A Salomon & Co Ltd. is considered a landmark decision and an undefeatable principle of company law. The case formally established the concept of separate legal entity whereby a company was considered an artificial person with its own rights and liabilities. While the House of Lords anticipated misuse of the concept of separate legal existence of companies, they considered it as a commercial necessity for entrepreneurship. The rigidity of the judgement caused dire consequences whereby companies have used the principle as a defense for fraud, misuse, and mismanagement and various grounds were established for the courts to be able to pierce through the corporate veil.

In this paper the significance of the Salomon case, the legal context under which the House of Lords passed it and the subsequent paradigm shift in company law is discussed along with grounds for which the corporate veil can be lifted. The inadvertent difficulties in fixing tort liabilities of group of companies has been detailed and potential solutions of modification of relationship between the holding company and subsidiary companies, and readjustment of relationship between the holding tortfeasor company and their tort victims have been suggested.

KEYWORDS: Companies Act 2013, Salomon Case, Separate Legal Entity, Piercing/Lifting of Corporate Veil, Group of Companies, Tort Liability, Agent relationship

INTRODUCTION

Section 9 of the Companies Act, 2013 states that companies have the capability of exercising functions as separate corporate individuals.[1] In the case of Salomon vs. A Salomon & Co Ltd. the doctrine of separate legal entity was established. The court held that a company is distinct from the shareholders of the company even if majority of the shares are held by one person.[2] The principle holds regardless of the number of shareholders. The decision made in the Salomon case is a landmark decision and is considered as the beginning of modern company law but has been more recently described calamitous[3] and insignificant due to its iron grip on company law.[4] It is virtually impossible to contest this principle and has dire consequences in tort cases brought against companies held by other companies. When a subsidiary company is insufficiently capitalized it becomes unable to meet its tortious liabilities, an exception which companies are using as a norm for their benefit by purposely establishing and conducting businesses through insufficiently capitalized subsidiaries.

ISSUES

Salomon vs. A Salomon & Co Ltd., a landmark case which established the doctrine of separate legal entity for companies, has contemporarily been losing its significance as the most important company law case due to various controversies and misuse. Due to the stronghold with which the Salomon’s case is applied in courts, traders and businessmen favor to conduct business as limited companies even when no outside capital or no business risk is involved. The protection conferred to the shareholders by courts is over and above that provided by the Parliament, and even though courts have been able to unveil the cloak of corporate personality they are prevented by the megalithic decision of the Salomon case in fixing appropriate liability.

RESEARCH AND ANALYSIS

In company law, laws are created to satisfy the social and economic needs of the shareholders, investors, and the management. Historically, it has been difficult to apply corporate legal personality while balancing the rights of the creditors. In Oakes vs. Turquand and Harding (1867), the House of Lords held that creditors have direct remedy against solely the company and not any members who constituted the company[5], setting the stone for the Salomon case. In Salomon vs. A Salomon & Co Ltd., the court agreed that the company was a legal person and that it had acted for itself. The facts of the Salomon case were such that the owner was made a preferred creditor over the unsecured creditors in a legal system that was designed to prevent fraud and mismanagement. The courts did anticipate the misuse of limited liability but considered the principle of separate legal entity as a commercial necessity which should be given more importance than the remote possibility of conflict, fraud, and misuse. By establishing independent legal existence, it was easy for the courts to deduce the legal competence, capacity, rights, and liabilities of a company. However, while providing the verdict in this case the court did not consider the morality of the business, they had only considered whether the statutory requirements were met and whether the conduct of Salomon was contrary to the intention of the legislation.[6]

In India, even before the Salomon case, the Calcutta High Court affirmed the concept of separate legal entity in the case of Re. Kondoi Tea Co Ltd. (1886). Due to its establishment in subsequent cases such as Abdul Haq vs. Das Mai (1910) and Turnstall vs. Steigman (1962), it was easy for courts to resolve the conflicts as the distinction between the company and the management was clear. In Abdul Haq vs. Das Mai (1910), Das Mai, an employee of the company sued the director for salaries due to him and since it had been established that a company is separate from its management, the courts held that the remedies lie against the company and not the director as the company is responsible to pay salaries to the employee.[7] In Turnstall vs. Steigman, (1962), a landlady tried to regain possession of her property from her tenants for her business. The court held that the property was held in her personal capacity and not by the business.[8] It can be observed that the principle of separate legal entity decreases the burden of courts in deciding cases as they can apply the strait jacket formula of separate legal entity to resolve conflicts.

The concept of separate legal existence does not confer absolute immunity. There are multiple circumstances where the courts exclude companies from benefiting from the principle of separate legal entity, fixing liability on the management and shareholders which is referred to as lifting or piercing of the corporate veil. The rationality is that an artificial entity cannot commit fraud or criminal acts and that there must be a natural person who is the mastermind of the acts. Grounds for lifting the corporate veil have been conferred under the Companies Act, 2013, through various judicial interpretations and under other statutes. For example, if person A fraudulently persuades a person to invest money into a company held by him, the corporate veil would be lifted under Section 36 of the Companies Act, 2013, and person A would be liable. In cases where companies are closely associated, the real character of the company has been determined and the corporate veil has been lifted. In Re London Housing Society’s Trust Deeds, [1940], the court held that the provident society and the company that held its assets are by law separate entities, but simultaneously stated that they are one and the same in substance as it was evident that the society and the company were structured to obtain benefits as a trust fund.[9] Other reasons why the courts may lift the corporate veil is if the company has involved in tax evasion[10], fraud or improper conduct[11] and criminal activity.

Although misuse in the case of one man and private companies was anticipated by the House of Lords in the Salomon case, an inadvertent immunity was created for groups of companies. During the same time of the Salomon case, the concept of groups of companies was arising. In English law, nothing prevented a company from being the shareholder of another company and in the case of the Great Eastern Railway Co vs. Turner (1871) it was held a company can be the shareholder of another company.[12] When two partnerships merge all the partners are partners of the merged partnership however in the case where one company acquires the shares of another, the shareholders of the acquiring company do not become shareholders of the acquired company. Instead, only the acquiring company becomes the shareholder of the acquired company. If the Salomon case is applied, then this makes parent company a separate legal entity from its subsidiary group companies. In such corporate structures, it has become cumbersome for tort claimants to obtain proper compensation as the groups of subsidiary companies are considered separate from the parent company. The parent companies in these cases are successfully able to shift losses of tort onto the government or the tort claimant themselves using this strategic structuring.

CONCLUSION AND RECOMMENDATIONS

To promote entrepreneurship and allow for easy analysis and comprehension of a company’s rights and liabilities, the House of Lords in the Salomon case limited its interpretation to the mere words and intention of statutory provisions. However, the case established a stronghold on succeeding cases whereby it rendered it highly difficult for courts to contest the principle of separate legal entity. Under the doctrine of piercing the corporate veil, courts were provided with various grounds under different acts and precedents by which the corporate veil could be lifted assigning liability to the management or shareholders of a company. While misuse was anticipated in single person private companies, the inadvertent consequence in preventing courts from administering justice was found in case of groups of companies especially in tort cases. Some recommendations in these cases would be:

·      Changes in the relationship between the tortfeasor parent company and the claimant.

·      Considering that a holding company acts as an agent of the subsidiary companies. If this is established, then courts would not be prevented by doctrine of separate legal entity. For example, in the case of In Spreag vs. Paeson Pty Ltd., due to the exercise of high control of the holding company on the subsidiary company the court considered the holding company an agent of the subsidiary company.[13]

With these changes the Salomon case would still hold relevant in contemporary times.

REFERENCES

[1] Companies Act, 2013 § 9.

[2] Salomon vs. A Salomon & Co Ltd [1896] UKHL 1, [1897] AC 22.

[3] O Kahn-Freund, ‘Some Reflections on Company Law Reform’ (1944) 7 Modern Law Review 54, 54.

[4] Daniel D Prentice, ‘Some Aspects of the Law Relating to Corporate Groups in the United Kingdom’

(1999) 13 Connecticut Journal of International Law 305, 316.

[5] Oakes vs. Turquand and Harding (1867) L.R. 2 H.L. 325.

[6] Salomon vs. A Salomon & Co Ltd [1896], supra note 2 at 4.

[7] Abdul Haq vs. Das Mai (1910) 19 IC 595.

[8] Turnstall vs. Steigman, (1962) 2 WLR 1045.

[9] Re London Housing Society’s Trust Deeds, [1940] Ch. 777.

[10] Income Tax Act, 1961 § 178.

[11] Gilford Motor Co. vs. Horne [1944] 1 Ch 935.

[12] Great Eastern Railway Co v Turner (1871) LR 8 Ch App 149.

[13] Spreag vs. Paeson Pty Ltd. (1990) 94 ALR 679.