Boyle and Bird in their book ‘Company Law’ credit the legislation of the 1840’s and the 1850’s as being responsible for the creation of the registered company that we can recognise today and while those commentating on the Salomon v. Salomon & Co. Ltd case make reference in particular to the 1862 Companies Act one could argue, persuasively, that it was the Joint Stock Companies Acts of 1856, the that provides the bedrock upon which the modern company was formed. This act consolidated and reformed previous legislation. It introduced the memorandum and articles of association while abolishing deeds of settlement and of equal importance it removed previous safeguards for limited liability. These changes in the law were in response to a particular economic reality, the need to finance growth. In conjunction with the skills of the entrepreneur and technological developments these changes helped to stimulate the economy by making it possible to raise capital for a business venture without facing the consequences of unlimited liability should the venture fail.
Some thirty years later Mr Salomon, a manufacturer of boots and shoes and trading under the name ‘A Salomon & Co.’ sought to turn his business into a limited company. He adhered to all that was required of him under the Companies Act 1862. There was both a memorandum and articles of association with the subscribers to the former being Mr Salomon himself, his wife and his seven children who duly met and appointed Mr Salomon and his two elder sons as directors of the new company. The capital was fixed at £40,000 being divided into 40,000 shares of £1 each. The company duly took over Mr Salomon’s business on June 1st 1892. The purchase money was paid in the following manner. As money came in (amounting to £20,000) this was paid to Mr Salomon who then returned it in exchange for fully paid up shares. The sum of £10,000 was paid him in debentures and the remainder with the exception of £1,000 which Mr Salomon retained went to discharge the debts and liabilities of the business at the time of the transfer which were thus wiped out in their entirety. No other shares were issued except the seven shares that were taken by the subscribers to the memorandum. Shortly after the transfer the company fell upon hard times. Mr Salomon not only lent the company money but had his debentures cancelled and reissued to a Mr Broderip who advanced him £5,000 which he gave the company in the form of a loan. This injection of cash was not enough to improve the company’s fortunes. When the interest to be paid became due and was not paid, Mr Broderip got a receiver appointed who then met Mr Broderip’s claim with a counter-claim which disputed the validity of the debentures on the grounds of fraud.
The liquidator’s case heard before Vaughan Williams J broke down completely. However, the judge suggested that the company had a right of indemnity against Mr Salomon, declaring the shareholders of the company were nominees of Mr Salomon. The counter-claim was amended accordingly. Vaughan Williams J. declared that the plaintiffs of A. Salomon & Co, Limited or the liquidator were entitled to be indemnified by the defendant A. Salomon. It is interesting to note that his Lordship was attempting to lift the corporate veil, something that a number of courts have done against the backdrop of the House of Lords ruling on Salomon v. Salomon & Co. Ltd in 1879. He stated “that this business was Mr Salomon’s business and no one else’s; that he chose to employ as agent a limited company; that he is bound to indemnify that agent, the company; and that his agent, the company, has a lien on the assets which overrides his claim”(2) He went on to say “In this case it is clear that the relationship of principal and agent existed between Mr Salomon and the company.(3) His Lordship had recognised and attempted to address what was to become one of the major exceptions (the company as an agent of an individual) to the Salomon v. Salomon & Co. Ltd ruling, one which would allow future courts to legitimately lift the corporate veil.
Mr Salomon appealed; but the appeal was dismissed thought the grounds for dismissal differed from those expressed by the lower court. Lindley L.J. intimated that Mr Salomon had acted fraudulently when he said “It is manifest that the other members of the company have practically no interest in it, and their names have merely been used by Mr Aron Salomon to enable him to form a company, and to use its name in order to screen himself from liability”(4) His suggestion that a fraud had been perpetrated by A. Salomon was clarified when he said “There are many small companies which will be quite unaffected by this decision. But there may possibly be some which, like this, are mere devices to enable a man to carry on trade with limited liability, to incur debts in the name of a registered company, and to sweep off the company’s assets by means of debentures which he has caused to be issued to himself in order to defeat the claims of those who have been incautious enough to trade with the company without perceiving the trap which he has laid for them”(5) While the case went to the House of Lords it is interesting to note that once again the court sought to lift the veil of incorporation in its attempt to discover a fraud which after 1879 would be considered another legitimate reason for lifting the corporate veil.
The House of Lords ruling on Salomon v. Salomon & Co. Ltd set the standard against which future cases would be judged. Lord Halsbury L.C. made it clear that it was not the courts role to interpret the Companies Act 1862, “The sole guide must be the statute itself”(6) He later went on to describe Vaughan Williams J. argument as a ‘singular contradiction’, “Either the limited company was a legal entity or it was not. If it was, the business belonged to it and not to Mr Salomon. If it was not, there was no person and no thing 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”(7) Lord MacNaghten in addressing Vaughan Williams J. assertion that the signatories to the memorandum of association were ‘mere nominees’ of Mr Salomon said “the Act requires that a memorandum of association should be signed by seven persons, who are each to take one share at least. If those conditions are complied with, what can it matter whether the signatories are relations or strangers”(8) Addressing the issue of limited liability and Vaughan Williams J. comments he said “If the view of the learned judge were sound, it would follow that no common law partnership could register as a company limited by shares without remaining subject to unlimited liability”(9) He dismissed the Court of Appeal’s suggestion that Mr Salomon had acted fraudulently and went on to say “It has become the fashion to call companies of this class ‘one man companies’. That is a taking nickname, but it does not help much in the way of argument. If it is intended to convey the meaning that a company which is under the absolute control of one person is not a company legally incorporated, although the requirements of the Act of 1862 may have been complied with, it is inaccurate and misleading”(10) It was held that the appeal be allowed, and the counter-claim of the company dismissed with costs (both in this hearing and below).
Both Vaughan Williams J and the court of Appeal saw it as the duty of the court to look behind the incorporation of the company. Each, for different reasons, felt that Mr Salomon was manipulating “the machinery of the Companies Act, 1862 for a purpose for which it was never intended”. (11) However, the House of Lords judgment firmly pulled down the veil of incorporation around the company and its members. It is telling, when Lord MacNaghten referring to Vaughan Williams J. comments on the case stated “Leave out the words ‘contrary’ to the true intent and meaning of the Companies Act, 1862”(12) It is clear that Lord MacNaghten and his colleagues held that their role was merely to apply and not to interpret the Companies Act, 1862 and that any such interpretation by the courts was out with their jurisdiction. Nevertheless, later courts have found it necessary to lift the veil of incorporation and over the years there has been a number of exceptions to the principle laid down by the Salomon case that the corporation is a separate legal entity.
Gonzalo Villalta Puig contends that the verdict reached by the House of Lords in the case of Salomon v. Salomon Co. Ltd created a double-edged sword. While the verdict helped to drive capitalism by established the company as a separate legal entity with limited liability and allowed it (the company) to enter into contracts in its own name it also helped promoted the evasion of legal obligations by allowing these benefits to be harnessed by small private enterprises. Goulding agrees with Puig but goes further by suggesting that individuals are encouraged to seek limited liability by becoming a limited company even when such a step is not necessary in their particular circumstances. These, and other criticisms have their basis in fact. In the years since the Salomon v. Salomon Co. Ltd ruling in 1879 there have been a number of instances where the strict interpretation of the law has been questioned in the courts and the courts have seen fit to look behind the corporate veil.
Farrar, in his book ‘Company Law’ outlines several categories under which the courts have sought to pierce the corporate veil, though he is quick to point out the courts have not done this in a systematic way. Rather than defining what is meant by the term ‘incorporation’ and what it does and does not encapsulate the courts have examined this area on a case-by-case basis. As such, they have maintained the integrity of the Salomon ruling while providing a degree of flexibility but only on a case-by-case basis. It is therefore up to the individual/s who feel they might have a justifiable grievance to take that grievance to the courts and there present a persuasive argument for the corporate veil to be lifted in order that their grievance can be remedied. This in itself can prove very costly and time consuming. Believing one has a justifiable grievance might not be enough for a party to pursue their claim in court as the costs and time constraints might prove prohibitive. While this is not highlighted, by Farrar, it can nevertheless be considered a potential form of abuse.
One reason that the courts might allow the veil of incorporation to be lifted is where it is suggested that a company is acting as an agent of another company or individual. Re FG (Films) Ltd [1953] 1 WLR 483, [1953] 1 All ER 615 (Chancery Division) illustrates this point. The applicant sought to have the film ‘Monsoon’ registered as a British film however, the Board of Trade refused on the grounds that the film had in reality been made by an American company, Film Group Incorporated. In the terms of agreement between the two companies, the American company agreed to finance the venture and provide all of the facilities required by the applicant to make the film. FG (Films) Ltd had no place of business other than their registered office. They had capital of £100 divided into 100 shares of £1 each. Ninety of these shares, were held by the American director while the remainder were held by a British director. Vaisey J. held that the company had been brought into existence purely for the purposes of enabling the film to qualify as a British film and that FG (Films) Ltd was the nominee of and agent for the American company.
This case illuminated the Salomon ruling. An agency must be shown on the evidence to exist. It cannot be inferred merely from who owns the shares or who controls the company as in the Salomon case itself and Lonrho Ltd v Shell Petroleum Co Ltd.. That is not to say that an agency cannot be created between the company and its major shareholder, but this must be done by express agreement between the parties.
The case of Smith, Stone & Knight Ltd v. Birmingham Corporation [1939] 4 All ER 116 was similar to that of DHN Food Distributors Ltd v. Tower Hamlets London Borough Council. In this instance the courts allowed a holding company to claim compensation as though it were the owner-occupier of the land on which its subsidiary was located. The land in question being subject to a compulsory acquisition by Birmingham Corporation. Counsel for the parent company successfully argued before Atkinson J that the subsidiary was an agent of the parent company. In deciding whether the subsidiary was carrying on the business as part of the parent’s business or was acting on its own as a separate entity was a question of fact and in arriving at his decision it was necessary to answer six questions:
- were the profits of the subsidiary those of the parent company?
- were the persons conducting the business of the subsidiary appointed by the parent company?
- was the parent company the ‘head and brains’ of the trading venture?
- did the parent company govern the adventure?
- were the profits made by the subsidiary company made by the skill and direction of the parent company?
- was the parent company in effective and constant control of the subsidiary?
While some suggest this approach is ‘conceptually incoherent’, had these become the guiding principles it would have allowed legal practitioners to determine the existence (or not) of an agency arrangement rather than have to argue their case in court.
DHN Food Distributors Ltd v. Tower Hamlets London Borough Council [1976] 1 WLR 852 3 All ER 462 (Court of Appeal) was similar in that the Court of Appeal recognised the group of companies as a single economic entity and allowed the holding company to claim compensation from Tower Hamlets. The company ran a wholesale cash-and-carry business from premises owned by its wholly owned subsidiary (Bronze) which had the same directors as DHN but carried on no business. Another wholly owned subsidiary owned the vehicles operated by DHN, but it, also carried on no business of its own. The Council compulsory acquired the premises which resulted in DHN having to close down. DHN could claim compensation only if it could prove it had an interest in the land over and above that of a licensee. The Court of Appeal held that they did. However, in the Scottish case of Woolfson v Strathclyde Regional Council (1978) 248 EG 777, (1978) 38 P & Cr 521, 1978 SLT 159, HL. (despite the similarity of both cases) the Scottish court refused to follow the line laid down by the DHN case and their decision was up held by the House of Lords. It was held that occupation and a legal interest in the land had to coincide. The distinguishing feature was that in the case of DHN, the company that owned the land was the wholly owned subsidiary of the company that carried on the business whereas, in the Scottish case the company that carried on the business had no control whatever over the owners of the land. The owners being Woolfson and a company in which he held two-thirds of the shares.
The courts by lifting the corporate veil as Stephen Griffin points out “fuses the subsidiary into the holding company, it does not recognise the separate identities of both companies”(13) However, Griffin argues the courts ruling on this matter have not been consistent and he offers Adam v. Cape Industries plc [1990] Ch 4, [1991] 1 All ER 929 (Court of Appeal) to highlight this inconsistency. An examination of this case will serve to illustrate two of Farrar’s categories, that of agency and the group enterprise.
Cape was an English company with wholly owned subsidiaries in a number of countries including NAAC (a marketing subsidiary) in America which supplied American users of asbestos through its links with various companies with in the Cape group. Some of these subsidiaries mined asbestos while others marketed it. In the state of Texas in American several hundred plaintiffs were awarded damages for personal injury due to their exposure to asbestos. The prosecution argued that Cape and its relevant subsidiaries should be considered as a single economic unit, that the subsidiaries were a façade behind which Cape operated and that an agency relationship existed between Cape and NAAC. The Court of Appeal held that the award could not be enforced against the parent company, Cape. Their Lordships rejected the argument that Cape and the relevant subsidiaries should be treated as a ‘single economic unit’. Slade LJ agreed that the courts have a duty to determine whether a company is present in a foreign country through a subsidiary and they must investigate that relationship. In doing so, there is no presumption of an agency relationship “…that the subsidiary is the parent company’s alter-ego” (14) It was perfectly acceptable for a company to arrange the affairs of the group in such a way that the business carried out in another country was the business of its subsidiary and not of the parent company. He agreed with the lower court in this matter and refused to infer an agency agreement between Cape and NAAC. Turning to the second point Slade LJ argued that it was perfectly acceptable for an organisation’s corporate structure to be arranged in such a way so as to ensure that any legal liability in respect to the groups future activities will fall on a particular member of the group. Cape was therefore entitled to organise the group’s affairs in the manner prescribed and as such they rejected the ‘corporate veil’ argument. With regards to the final point, that of agency, they agreed with the lower court and held that NAAC was a legal entity separate from Cape. Griffin is uneasy at the rigidity in which the Court of Appeal held to the Salomon principles. He contends that the parent company controlled the reigns of NAAC as both its policy and commercial were dictated by Cape and as such the veil of incorporation should have been lifted.
Where a party is seeking to perpetuate a fraud the courts will allow the veil of incorporation to be lifted, as was the case of Gilford Motor Co. Ltd v. Horne [1939] Ch 939 (Court of Appeal) and Jones v. Lipman [1962] 1 WLR 832. In the former case EB Horne was previously a managing director of the plaintiff company and as such he had signed a covenant not to solicit customers from the company should his employment with the company be terminated. When his employment was terminated he set up his own business but on advice he ‘caused’ a company to be formed ‘JM Horne & Co Ltd’ in which his wife and the company’s sole employee were shareholders and directors. The company proceeded to take over EB Horne’s business and solicit customers from Gilford Motors. Farwell J held that the covenant had been broken but the covenant itself was too wide and therefore against public policy and as such he declined to enforce it. Farwell J was of the opinion that JM Horne & Co. Ltd was a conduit through which Horne sought to carry on his business while evading the terms of the covenant. On appeal Gilford Motors was granted an injunction against both defendants (Horne and JM Horne & Co. Ltd). Despite the defendant company (JM Horne & Co Ltd) being a separate entity from EB Horne the Court of Appeal held that it was created to circumvent the covenant signed between Horne and Gilford Motors and JM Horne Co Ltd was EB Horne in another guise. The courts in allowing the corporate veil to be lifted were able to uncover the true intentions of EB Horne.
In time of war the court can lift the corporate veil to determine whether a company can be characterised as an, ‘enemy’. In Daimler Co Ltd v. Continental Tyre and Rubber Co (Great Britain) Ltd [1916] 2 AC 307 (House of Lords) the issue was whether the company could be sued for the recovery of a debt when a state of war existed between England and Germany. The Continental Tyre company was incorporated in England, but all of its directors resided in Germany and all of its shares except one were held by those directors. The secretary held the remaining share, resided in England and was a British subject. The lower court held that the company was incorporated under the Companies Act and was therefore an English company despite its directors being German and an English company cannot cease being an English company because a state of war exists between England and the country in which that company’s directors reside. The House of Lords however reversed this decision on the grounds that the secretary was not authorised to commence the action. More importantly it held that the company though incorporated in England was capable of acquiring an enemy character.
This decision blurs the distinction between politics and the law and while the exceptions to the Salomon ruling are there to improve the quality of law handed down in terms of equity and fairness it can be argued that House of Lords abused the Salomon ruling by offering a political solution rather than legal ruling to a current dilemma.
On matters of tax the courts are, on occasions, prepared to lift the corporate veil and disregard the separate legal personality of companies as was the case in Firestone Tyre and Rubber Co v Llewellin (Inspector of Taxes) [1975]. Reasons for lifting the corporate veil might include companies seeking to evade tax or where they are operating over liberal schemes for the avoidance of taxes.
Since the Salomon ruling in 1879 companies have become more and more sophisticated and while the various Companies Acts have in some respect failed to keep up with this growing sophistication it has been left up to the courts to set the guidelines. Companies are no longer the single entities they were one hundred plus years ago. Today, the group of companies exist and with that a whole new set of problems have emerged.