To what extent is the rule contained in the Salomon v. Salomon & Co. Ltd judgement open to abuse?

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To what extent is the rule contained in the Salomon v. Salomon & Co. Ltd

judgement open to abuse?

The company as a separate legal personality from that of its members as defined by the Companies Act 1862 was established in common law by the House of Lords in 1879 when they delivered their judgement in the case of Salomon v. Salomon & Co. Ltd. Indeed, this case is now seminal, with both practitioners and students of the law referring to it as the foundation upon which modern company law is based. However, although the outcome of Salomon v Salomon & Co. Ltd is now firmly embedded that is not to say it has not been prone to the effects of the occasional tremor. Since this ruling and some might argue prior to this ruling by the House of Lords questions relating to the interpretation of the act and its scope have been hotly debated.

While some see this ruling as clearly interpreting the 1862 act at common law others contend that such an interpretation is too rigid and clearly open to abuse. It would be argued that a separate legal personality in conjunction with limited liability offered the nineteenth century entrepreneur the protection they desperately needed if their business ventures were to grow and expand beyond their personal resources. Others would contend that this ruling was to the detriment of the company’s creditors, allowing the unscrupulous individual or individuals to set up a limited company at little expense and little or no risk to themselves.

Indeed, some detractors of the outcome of the Salomon v. Salomon & Co Ltd ruling have referred to such companies as a “sham”, “a screen” and “a mere fraud”. These, and a plethora of similar terms illustrates perfectly, as Murray A. Pickering states, “the degree of uncertainty on the part of the courts on some occasions when dealing with the separate existence of the company” (1).

The uncertainty created by the House of Lords ruling between helping the entrepreneur and protecting the creditors of the business has seen that the principles of the company as a separate legal entity with limited liability not go unchallenged.

Since 1879 companies have become more complex in their design and their operation and with out any radical changes in statute to incorporate these, it has been left largely to the courts to respond to these developments. The question of abuse by one or more individuals of the privileged status of the incorporated company has frequently come before the courts since the House of Lords ruling. For instance the potential of a party or parties to operate behind a limited company and perpetrate a fraud upon the company’s creditors has been recognised and in recent decades the rise, and in some instances the dominance, of the group of companies (conglomerates and multinationals) has seen the courts set down a number of exceptions to the general principle of incorporation with its inherent benefits as laid down by the Companies Act 1862 as interpreted by the Salomon case.

While Salomon v. Salomon & Co. Ltd might form the foundations of modern company law, over the years those foundations have been made more pliable with the courts recognising a number of instances whereby the veil of incorporation can be lifted so as to allow the courts to determine the true nature of the organisation.

Before one considers the potential for abuse of the rule as contained with in the Salomon v. Salomon & Co. Ltd case it would be prudent to begin by examining why the law in relation to the company needed to be changed. The background surrounding the eventual House of Lords judgement will then be reviewed before consideration is given to the actual judgement itself. From this vantage point it will then be possible to consider in some detail the potential for abuse together with practical illustrations of how the courts and statute have sought reduce the potential for abuse.

 Prior to the 1840’s there were two routes available to someone seeking to create a company. The first required the company to be incorporated by Royal Charter which in effect gave the company monopolistic power with in its sphere of influence (as defined by the charter). Indeed, during the seventeenth and eighteenth centuries this was the vehicle that allowed the British Empire to prosper. The other route was for a company to be incorporated by Parliament.  However, this route was both time-consuming and expensive and could only be justified in the case of very large undertakings such as the development of the railway. By the middle of the eighteenth century Britain was facing growing competition from its traditional European rivals (in particular France and Germany) and from the rapidly developing and industrialised United States of America. Indeed while the vast majority of Britain’s economic wealth rested in the hands of family run enterprises America was witnessing the creation of the conglomerate in the hands of such people as Andrew Carnegie (1835 – 1919) and J.P. Morgan (1837 – 1913). While Britain had the skills and abilities to compete, the inability for an individual or a group of individuals to raise capital to create comparable enterprises was strangling economic development. It was common practice to insert provisions within the charter of a trading corporation which allowed ‘leviations’ on its members to pay the corporations debts, a factor which stifled entrepreneurial risk taking.

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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 ...

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