Company law; separate legal identity of company; limited liability of company; validity of security obtained by member of a company over the company's assets.
Facts: Over a period of 30 years, Aron Salomon established a successful boot and shoe manufacturing business, operating as a sole trader. Salomon was married, with five sons and a daughter. Four of his sons were employed in the business. In 1892, Salomon decided to turn his business into a private company limited by shares. At the time, the Companies Act required a company to have at least seven members, each of whom must have at least one share of whatever value. To comply with these requirements, Salomon, his wife and five of his adult children became shareholders in the company. The company, on being incorporated, agreed to pay Mr Salomon £30,000 to take over his business. In payment of this amount, the company gave Mr Salomon 20,000 paid up £1 shares in the new company, plus 10,000 £1 ‘debentures’ which gave Salomon a preferential right to be paid from the proceeds of the company’s assets. Mrs Salomon and the five children only took a single £1 share each. Not long after the company was formed, industry-wide strikes drove the business into insolvency, and the company was wound up. The company could not pay both the debt secured by the debentures and the debts owing to other unsecured creditors.
Issue 1: Had Salomon properly created a company with a separate legal persona from himself?
Decision: The company was validly created in accordance with the requirements of the then Companies Act; it acquired a legal persona separate from that of its members.
Reason: It was argued that it was contrary to the intention of the Companies Act to allow Salomon to create a company with a separate persona when the company essentially consisted only of the members of his family, with himself remaining in control of the same business he had been running before. The appeal court disagreed, holding that the Companies Act laid down certain minimum requirements for the formation of a company, with which Salomon had complied.
Lord MacNaghten said (at [51]):
The company is at law a different person altogether from the subscribers to the memorandum; and, though it may be that after incorporation the business is precisely the same as it was before, and the same persons are managers, and the same hands receive the profits, the company is not in law the agent of the subscribers or trustee for them. Nor are the subscribers as members liable, in any shape or form, except to the extent and in the manner provided by the Act. That is, I think, the declared intention of the enactment.
Issue 2: Was the company created by Salomon capable of creating valid securities in favour of Salomon?
Decision: In the absence of fraud, the company was able to issue debentures to secure payment of monies owed to Salomon.
Reason: Salomon had created a company with a separate persona and this company was entitled to issue debentures to its creditors, including those who are also members of the company. The issue of valid debentures to Salomon meant that, on the winding up of the company, he was entitled to be paid before other unsecured creditors of the company.
Lord MacNaghten said ([53]):
A company, too, can raise money on debentures, which an ordinary trader cannot do. Any member of a company, acting in good faith, is as much entitled to take and hold the company’s debentures as any outside creditor. Every creditor is entitled to get and to hold the best security the law allows him to take.