CITATION : [1897] AC 22 1. Facts Aron Salomon had operated a sole trader leather boot and shoe business in Whitechapel and wished to turn this into a limited liability company in 1892. This was named A. Salomon & Co. Ltd. Under the UK Companies Act 1862, public limited companies must have a minimum of seven subscribers. In order to comply with this legislation, Salomon had his family as part of the company. This consisted of seven people. Salomon himself along with his wife and five children, each owned one share worth £1. This meant the company had initial capital of £7. Soon after incorporation Salomon sold his leather business to the company, for a price of £38,782. This was paid for by: Issuing Salomon 20,000 fully paid up shares (£1 each) £10,000 of secured debentures meaning Salomon had a floating charge over the assets of the company as a secured creditor. £8,783 in cash and other forms of payment. Overall, Salomon owned 20,001 shares compared to his family who owned only one share each. Salomon was the managing director and the remainder of his family did not play an active role in the running of the business. However, following approximately one year, the business had gone into voluntary liquidation due to a general downturn in the boot trade, strike by shoe workers and expensive litigation. When the liquidators began selling off the assets of the company, there wasn’t enough money to pay everyone. Salomon received payment of his share of money (as the secured creditor) and there was nothing left for the unsecured trade creditors. The liquidator then brought a claim on behalf of the unsecured creditors. The claim was that the company had been a sham / alias for Salomon therefore he should be held personally liable for the debts of the company, the debentures should be void and he should indemnify. 2. Issues Whether the Company is a separate legal entity? Is a company that is largely controlled by one person (one-man company) able to be seen as a separate legal entity or are they merely an agent/puppet? Were the debentures issued to the sole owner of the company a violation of the 1862 Act or an act of fraud? Whether limited liability applies when the company is fully controlled economically by one individual? 3. Judgement A. Court of First Instance (Vaughan Williams J.) The trial judge ruled in favor of the unsecured creditors. He believed that Salomon had used the formation of the company as a ‘device’ to operate his business whilst having limited liability and avoiding any risk. The trial judge ruled that the company was merely an agent of Salomon and decided that he should be held personally liable for the debts and the debentures were void due to fraud. B. Court of Appeal The Court of Appeal agreed with the trial judgements but provided slightly different reasoning. The Court stated that by forming the company and issuing the debentures, Salomon had misused the intention of the Companies Act 1862. The Court felt that Parliament intended to create companies with seven real separate individuals rather than one person with six phoney shareholders. Therefore, Salomon was held personally liable. C. House of Lords (Final Appeal) The House of Lords ruled unanimously that the previous judgements were incorrect and decided the case purely based on the literal interpretation of the statute. Main points made by the Lords were: Separate Legal Entity: Once a company has been correctly incorporated under the Act, the company will be a separate entity with the law. It does not matter what the motives of the founders or how much control was over the company as long as everything was correctly completed. Literal Interpretation: Under the 1862 Act, the company needed seven subscribers who would have at least one share. Salomon and his family met all the requirements. The law never specifically states that the subscribers need to be financially independent or actively involved in running the firm. Debentures: A business owner can legally sell their business to their own company and receive secured debentures. This will mean they will rank higher than unsecured creditors when in insolvency, as long as there was no actual fraud. No Fraud Found: The Lords commented that there was no actual fraud or deception. Creditors are entitled to look at public registers and documents regarding the company to see how they are structured. 4. Conclusion Corporate Personality: Salomon v. Salomon created the fundamental principle of corporate personality (veil of incorporation) this means that the company will be completely separate to the individuals that created it. Limited Liability: It confirmed that even when one individual owns nearly all of the company’s shares they are still protected by limited liability. Veil of Incorporation: Whilst this case created a strong barrier between corporate personality, the law has found some narrow exceptions (fraud, sham and evasion). This allows the courts to pierce the corporate veil. However, Salomon is the definitive rule.