The Salomon
decision was a scandalous one which unleashed a tidal wave of irresponsibility
into the business community; however it was needed at the time due to economic
and commercial reasons. Discuss in context of historical significance and give
your opinion if it is indeed a ‘necessary evil’?
Introduction
The Salomon decision was one of those decisions which laid
the foundations of some basic concepts which are now considered as extremely
important. Prior to the decision of the case called Salomon v Salomon & Co
Ltd [1897], there was nothing as such as separate legal entity and limited
liability. The induction of those concepts brought some advantages accompanied
with some disadvantages which were latter tacked by lifting the corporate veil.
Discussion
Earlier,
businesses organized in the form of partnership had to form various contracts
in an extremely complex manner where each party was required to be a part of
that contract. Now, companies are recognized as a distinct legal person; meaning
that the companies can form contracts; subsequently, the processes of forming contracts
became easier. For instance, if the Co. has to form a contract then contract is
made on the behalf of the company and only those persons are allowed to form a
contract who are authorized to act on behalf of the company (as those
authorized individuals are recognized in the articles of association of the
company or settled by a formal declaration of the board of directors);
therefore the transformation of companies in to separate legal entities made
everything simpler and provided the company with the contractual capacity as
demonstrated in the following case:
Lee v Lee’s Air Farming [1961]
Facts:
Lee was the pilot of the company and held majority of the
shares and was the only director. He died in a plane crash and his widow wanted
compensation which was payable to the widows of the deceased employees. The
insurance company argued that he was the owner but not the employee and made
contract with himself.
Held:
Lee’s widow was entitled to the compensation as the court
said that Lee had not contracted himself; rather he had a contract with the
company which was a separate legal entity. In this case, the company was
considered as owner and Lee as employee.
Secondly,
from the perspective of a capitalist like Aron, the provision that protects the
owner’s personal property from being involved in the process of insolvency is a
great advantage which allowed people to take more risks. Ultimately, this
particular decision had historical significance in terms of expansion of
businesses which eventually resulted in economic success.
In
contrast with this, the principle introduced by Salomon decision came up with
some ethical issues which involved moral hazards as well as adverse selections.
For instance, if Aron’s property is protected; then in case of insolvency, individuals
associated with the corporations only have company’s assets available, hence
Aron or other stakeholder possibly will care lesser about the business and may
have some moral hazards which may perhaps result in dishonesty, as the
liability is limited to the extent of investment. Consequently, this is the
point where management or stakeholders will accept lesser responsibility which
can eventually result in failure of companies. Ultimately, the ethics need to
be question as nobody is exposed to the risk in case of failure of payments to
third parties.
In various cases we
witnessed that, the side effects of considering company as separate legal
entity or not can be intense. Many individuals consider Salmon Principle as
“Unyielding” and the facility to shield oneself form liability by incorporating
a company is open to abuse; therefore for situations where the application of
Salmon principle may result in severe consequences; the corporate veil is lifted
by the statute or by the courts to protect the legal rights of the
related parties; which are considered to be the most extreme circumstances.
Following are some of the instances where corporate veil is lifted:
ü Sham
or a fraud
ü Single
Economic Unit
ü Agency
Following are the
cases which laid the foundation of lifting the corporate veil (that was
initially created as a result of Salomon v Salomon & Co Ltd [1897]:
Gilford
Motor Company Ltd v Horne [1933]
Facts:
Mr. Horne (former employee) was bounded by the covenant of not soliciting the
customers from the former employers. In order to do so, he formed a new company
and argued that he was bounded by the covenant but not the company.
Held:
Court discovered that the company was just a front for Mr
Horne and issued an order against Mr. Horne.
ü Similar
results were seen in following case:
Jones
v Lipman [1962]
Facts:
Mr Lipman entered into an agreement with Mr Jones for the sale of land. Mr
Lipman then formed a company to avoid this particular transaction and conveyed
the land to the company then claimed that he is no longer owner of that land;
therefore he can’t comply with the conditions.
Held:
Court discovered that the company was a façade or front for Mr. Lipman and
granted an order for the specific action.
The application of
salmon principle can cause some serious problems in critical situations. For instance, if there is a parent or holding
company which owns and controls all other subsidiaries and every company formed
in such a way that the structure provides the benefits of limited liability to
every entity. In such kind of cases, if
Salmon principle is applied then if something goes wrong with one of the
companies or parent company then the shareholders of other company with limited
liability can’t be touched.
DHN Food Distributors Ltd v Tower Hamlets [1976]
Held:
Court held the group of companies was in reality a single economic entity
and declared that it should be treated as one.
After two years, the following
case was witnessed:
Woolfson
v Strathclyde RC [1978]
Held:
Criticized the views made in DHN Ltd v Tower Hamlets [1976] relating to treatment
of group of companies as one; and held the corporate veil to be upheld unless
it was a façade.
Following case made an
important move and introduced more certainty towards the explanation of the
issues in Salomon principle; and pointed the stages where the corporate veil
can be lifted.
Adams
v Cape Industries plc [1990]
Facts:
Cape was an English company which had subsidiaries, named Capasco and NAAC. 462
people took a legal action against Cape, Capasco, NAAC; due to the personal
injuries arising from the installation of asbestos in a factory. Subsequently,
NAAC was shut down by the Cape and was twisted into new subsidiaries to
minimize the presence of Cape. In addition to this, additional 206 similar
actions were commenced and default judgments were entered against Cape and
Capasco. Cape sold the mining and marketing business and left with nothing in US.
Adams sought the enforcement of the US default judgment in England.
Held:
Court recognized the ‘mere façade concealing the true facts’ is an entrenched
exception to the basic principle of Salomon. Court discovered that the Cape’s
intention was to minimize its presence but there was nothing illegal with this and fount that this was a
straight forward application of agency principle. If the subsidiary was Cape’s
agent, then the actions of the subsidiary would bind the parent. The court
found that the subsidiaries were independent businesses free from the
day-to-day control of Cape and with no general power to bind
the parent.
The mentioned cases
laid the foundation of lifting of the corporate veil. Following are the
situations where corporate veil is lifted:
1. Where
court is interpreting a statute
2. Where
company is a mere façade.
3.
Where subsidiary is acting
as an agent
Conclusion:
In
my opinion, the outcome of Salomon v Salomon & Co. [1897] in the
form of salmon principle laid the foundation of separate legal entity and
limited liability concept by creating the veil of incorporation. This was one
of the reasons of the economic development, as it reduced potential risks for
the risk takers, but at the same time it had some disadvantages in the form of
horal hazards and adverse selections; therefore this decision and the principle
at the initial stages can be said as scandalous to some extent, but at the same
time it was essential. Moreover, at that stage the decision was immature as no
further litigation took place. Most importantly, by that time this principle
was not furnished as courts discovered few instances where they allowed lifting
the corporate veil; which ultimately balanced the situations.
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