Essay question

The judgment in Salomon v Salomon [1897] should have been decided differently. It established that a correctly registered company possesses a legal identity separate from its shareholders. The result is a situation where unscrupulous traders may exploit a position of trust, and it has left unsecured creditors in a precarious position.

Using appropriate case law and practical examples, critically assess this statement.

Justify your conclusions.

Answer:

The question requires a critique of the ruling in Salomon and the implications of a company possessing a legal personality separate from the owners and shareholders.

The veil of incorporation separating the company from its shareholders should be included in the discussion. Due to the company’s separate legal personality, the courts have often been unwilling to ‘lift the veil’ and find out what the directors actually did in running the business (what decisions were taken, and by whom and so on).

Whilst the veil is effective, it has been ‘raised’ by the courts where it has been deemed relevant. The courts have been notoriously unwilling to establish clear rules as to when the veil will be lifted.

However, the company must not be established to commit some fraud (Jones v Lipman) or to attempt to circumvent contractual agreements or the veil will be lifted to identify the true nature of the undertaking (for example a ‘sham’ company - Gilford Motor Co. Ltd v Horne).

A crucial element to the answer should include a discussion of the consequences when the company goes into liquidation and the creditors attempt to recover monies. The shareholders’ liability is limited to their investment, and the directors may have established some creditors as secured, whilst other are unsecured with very little scope of recovering money owed. This can have disastrous financial consequences (particularly for smaller companies).

Here, Salomon established himself as a secured creditor and on the newly formed company’s insolvency, he and another creditor received the remaining money whilst unsecured creditors received nothing. The Lords held that there was no sham or deception in the formation of the company, and Salomon was a secured creditor. He was, as such, entitled to the protection afforded this status.